Slouching Towards Wall Street… Notes for the Week Ending Friday, 13 May 2011
Happy Friday the 13th, Osamaratnam!
Washington should be feeling pretty good this week, having wrought justice on two enemies of the American Way of Life.
The raid that got Osama bin Laden was surprising, as Washington actually managed to keep a secret. Given how much planning had to go into the raid into Pakistan, it is impressive that there were no leaks. Afterwards, having kept the secret for so long, they couldn’t shut up about how the wonderful men and women of the top secret team infiltrated a friendly nation and blew away one of the world’s most wanted men right in the suburbs of the seat of government. We expected a feel-good television documentary about the brave men and women of Seal Team 6, along with their home addresses and slow-motion footage of them tossing their children in the air at family picnics in readily-identifiable suburbs of Reston, VA.
Bin Laden was a marked man from the moment George Bush, Jr. trained America’s crosshairs on him. Rajaratnam, too, was riding for a fall. The Justice Department were so convinced of their case they left him no space for a deal of any kind, and we were not surprised at the verdict returned on Wednesday. You should enjoy your Friday the 13th. We will not have another one until January.
Things could actually have gone worse for Mr. Rajaratnam. A piece in the Shanghai Daily (10 May, “Insider Trading Netted Millions For Corrupt CEO”) tells of Mr. Xiao Shiqing, a former Chinese securities regulator and CEO of China Galaxy Securities Co., a Chinese investment firm. Mr. Xiao, convicted of bribe taking (15.46 million yuan) and of profiting from insider trading (100 million yuan) has been sentenced to death.
As reported (Shanghai Daily, 10 May, “Insider Trading Netted Millions For Corrupt CEO”) the sentence has been deferred for two years, a deferral that, the paper reports, generally indicates the sentence will be commuted to life in prison. We can think of a few financial miscreants on our own shores who merit like treatment.
The Rajaratnam conviction is a serious victory of the Justice Department, but we should not be distracted. So far, America’s financial regulators have quite palpably failed to catch Bernie Madoff and Raj Rajaratnam. Madoff gave up because the market was about to crush him, and Rajaratnam’s downfall was a Department of Justice case. The masters of the lookaway, from Wall Street to the Washington Beltway, would have us believe they are cleaning up the markets and getting tough on abuses. Nothing could be farther from the truth.
While they are admittedly egregious, and while serious money is involved, neither Madoff’s fraud plea nor Rajaratnam’s insider trading conviction goes to the heart of what’s wrong with our system. The unfettered greed, the rampant dispossession of the majority of market players, and the deliberate structuring of law and regulation to benefit those already most greedy and most powerful would have been mitigated not one iota had Messrs Madoff and Rajaratnam run their businesses completely by the book. We would be fascinated to review an actual historical record of actual trading done by Bernard Madoff — if, indeed, such a thing exists. Given the performance of most stock pickers, it would not surprise us to learn that Madoff’s investors would not be any better off today had he actually managed their portfolios, selecting stocks and buying and selling on his own trader’s acumen. Returning yet again to flog this long-dead mare, it is obvious that a great many of Madoff’s investors were savvy enough to know that no one gets consistent returns in the markets like he was producing, and they therefore knew he was doing something illicit. They just believed themselves to be the beneficiaries, and not the victims.
This does not excuse Madoff’s behavior, nor Rajaratnam’s. It creates, rather, an outer ring of guilt that has been breeched only slightly by allegations against money manager Ezra Merkin and the Wilpons — as savvy professionals who presumably should have known something was wrong. And in the wake of Wizard of Lies, the new book by NY Times reporter Diana B. Henriques, other allegations have been brought more forcefully (The Forward, 10 May, “The Jewish Roots Of Madoff’s Crime”) describing an inner circle of early investors who clearly were in a position to know that Madoff was running a scam.
But Rajaratnam earned about $64 million from his illegal dealings, and mirabile dictu, the Madoff trustee has said investors could very well get back 100 cents on the dollar on their original investment. Let’s face it: when’s the last time your stockbroker got you out even?
Our market is ringed by people who know the game is rigged, and just hope to be able to get in, get their piece, and get out while the getting’s good. This is an entire economy of greed, a society structured like Dante’s Inferno, where those closest to the inner circle get to keep the most swag, while those at the periphery clamor in an eternity of torment for their share.
Back to China. We wonder whether our foreign ally may be exacting revenge. As holders of give-or-take a trillion dollars of our debt, right now they don’t have too much to thank America for. The last couple of weeks have seen some inconvenient stories about Chinese stocks under scrutiny be US regulators. Considering how poor a job the US regulators do of policing our own markets, it makes sense that the SEC would turn their attention elsewhere. The Financial Times reports (5 May, “Carlyle Faces Questions Over China Investments”) that the Carlyle group has substantial stakes in two US-traded Chinese companies, both of whose stocks were halted because of allegations of fraud.
Unlike other self-important prognosticators, we actually delight in saying “I told you so.” Loyal Screedophiles will recall our item (21 August 2009, “The China Syndrome — Are ETF Investors Buying A HOG In A Poke?”) which discusses Dallas, Texas-based Halter Financial Group, a company whose web address “reversemerger.com” indicates their niche in the financial marketplace.
Halter specializes in taking Chinese companies public in the US through reverse mergers. When we perused the firm’s website back in 2009, we were unable to find a clear reference to Tim Halter, founder and CEO of the company. Halter’s website has since been updated to feature a slideshow from the Halter Financial Summit — China in a Changing World, a conference hosted in Shanghai in April of last year. The keynote speaker was former president George W. Bush, Jr., whose photo now graces Halter’s home page. Allowing our conspiracy-paranoid mind to run free, we can only speculate how former president Bush’s twin involvements with Halter and with the Carlyle Group might have played into the private equity behemoth becoming involved in this China play. [Full disclosure: Hedgeye CEO Keith McCullough was a portfolio manager the Carlyle-Blue Wave hedge fund, and your columnist was the fund’s compliance officer. Carlyle-Blue Wave was a joint venture partnership with the Carlyle Group, thus we were not directly employed by Carlyle.]
The FT reports on Carlyle’s holdings in China Agritech (symbol CAGC) a stock it acquired through a 2009 private placement made through two Carlyle-affiliated entities, according to public records. The $10 million acquisition represented a meaningful infusion for CAGC, which reported $76 million in top-line revenues in 2009. For Carlyle, with over $90 billion in assets, it is hardly a major investment. Speculation about Carlyle’s involvement included questions about the role of a young Carlyle VP out of their Shanghai office who has a seat on CAGC’s board.
There was also a report that made the rounds of the world of financial electronic Samizdat. Issued by an operation called Lucas McGee Research, (February, “China Agritech: A Scam”) the unattributed piece carried a boldface (in both senses of the word) statement that “writers and contributors to this report have short positions in CAGC and therefore stand to realize significant gains in the event that the price of the stock declines.” The report alleges that no trucks were seen going in or out of CAGC’s fertilizer factories, even though the company supposedly produces 50,000 tonnes of organic fertilizer annually. The quick and dirty analysis (one truckload = 20 tonnes; 2500 truckloads = 50,000 tonnes) led the report’s authors to surmise they should see an average of 10 trucks passing in and out of the factories every day, instead of the zero they report having seen.
So far nothing has been proven, but the SEC is asking questions about these companies’ financial reporting (WSJ, 10 May, “Chinese Stock Halt Adds To ‘Reverse Merger’ Frustration”) and imposing trading halts until they get clear answers. CAGC has been held for trading for two months. The Journal article does not make it appear there will be action any time soon, but there are no clear allegations of fraudulent dealings. We hasten to point out that nothing we have seen accuses Carlyle of wrongdoing, nor do we intend to imply any improper action by them. Anyone is capable of making a mistake, but when you’re the Carlyle Group, the negative PR consequences can be considerable.
There’s lots of smoke swirling around right now. A well-regarded Wall Street money management firm was sucked into the fray (Bloomberg BusinessWeek, 15 May, “Wall Street Scion Lost In China Agritech As Shorts Cry ‘Scam’”) when 29 year-old Jesse Glickenhaus bought $4 million worth of CAGC for his family-owned asset management firm. His grandfather, well-regarded investor Seth Glickenhaus, said he had “never run into” such a situation. At age 97, “never” is a long time. In what looks like an orchestrated bear raid, internet reports are flying from all corners of the world, in addition to the Lucas McGee report. But for the availability of the report on line, McGee appears to be hard to get hold of. Businessweek said emails and phone messages went unanswered, and McGee is not registered with the Hong Kong financial authorities.
The consequences of a trading halt are that no one can get their money out of a position. Owners can not liquidate their shares, and shorts can’t cover. This is something of a bonanza for the clearing firms, which get to collect interest on the credit balances, and charge interest on the debits associated with the frozen investor positions.
Options traded on these shares also can not trade — there is no underlying market to quote them against. Option holders must wait for expiration, then make a best guess whether to exercise their options, or allow them to expire. Says the Journal, “borrowing rates for many of the stocks have skyrocketed, a boon for hedge funds and other owners that are willing to lend shares out.”
When the illegal shorting business came to a particularly ugly head, back in 1995 (see last week’s Screed), regulators sought the logical solution: take what is illegal, and make it legal. Short selling rules were stepped up, and more procedures were put in place to ensure that a short seller would be able to deliver stock on settlement date. What it really ensured was that clearing firms should increase their investment, as the stock loan business continues to be a major profit center for clearing firms and prime brokers, as well as hedge funds and other large firms that hold large and diversified stock portfolios.
As we have discussed in past Screeds (8 May 2009, “I Am Joe’s Trade”) major Wall Street firms routinely engage in naked short selling on a massive scale, though we can not measure it, because of the way they account for it. This naked shorting is not only legal, it constitutes one of the biggest profit centers in the financial markets. Clearing firms, prime brokers, hedge funds, and other substantial holders of large diversified portfolios loan securities for short sellers. Many firms make a business of loaning against what is known as an “easy to borrow” list — a blanket approval for short sales for a single trading day. Stocks on the easy to borrow list do not have to be located individually on a trade-by-trade basis. Some firms track the positions on their lists during the course of the day and send notification to brokers when the quantities available for borrowing get low. But some firms don’t meaning that if a stocks gets talked down, and short sellers start flooding into the name, by the end of a single day it is possible that more stock has been sold in the market than exists in the hands of the clearing firms for delivery. Naked shorting? By definition, yes. Illegal? Lobbyists are undoubtedly browbeating the SEC even as you read this.
The Chinese are smart. They appear to have taken the most important page out of Wall Street’s book: create a good story, and people will buy it without looking too closely. CAGC has gotten its money, all based on a story. Jesse Glickenhaus says he focused on the fundamentals, and it is implied that one important factor in his decision was the Carlyle stake. Any risk manager will tell you to get to know the market into which you are about to plunge. Keynes’ dictum certainly holds true for Chinese reverse-merger companies with opaque financials: the market can remain irrational longer than your cash can hold out.
It remains to be seen whether CAGC is a real company. Their US banker, Halter Financial, has a niche in the business of reverse mergers for Chinese companies. Like their client, it remains to be seen whether they have a real business model, or whether their Chinese shell companies are just so many empty pickup trucks passing in and out of the gates of a factory where nothing is manufactured. The SEC trading ban may clarify things, because sooner or later the shorts will want their money. And in our experience, the shorts are the ones in control, very much like the mysterious and oceanic sway of the market itself. We might suggest a corollary to Keynes’ Irrationality Principle: the Shorts can remain short longer than you can continue holding a long position at such a depressed price.
Note to would-be Osamas and Rajaratnams: the poor suckers who got involved with the mob made two mistakes: they had to split their take, and they could have been killed. It all comes from being in a rush to get paid. The thugs wanted it all, and they wanted it now, and they are gone. The Chinese are taking their time, building their capitalist edifice patiently brick by brick. The Goodfellas’ motto is “F*** you, pay me!” In this game, the smart money is on the Chinese who are working patiently and methodically.
Selling short a stock on a US exchange is not the same as shorting China’s business model. Confucius says, “It does not matter how slowly you go, as long as you do not stop.”
Brazil’s congress has passed a law requiring underwear labels to carry health advisories. Men’s underpants will discuss the importance of a prostate exam, while women’s underwear will urge wearers to be checked for cervical and colon cancer, and to use condoms to prevent STDs. Bras will encourage self-examination for early signs of breast cancer. The bill has gone to President Rousseff — herself a cancer survivor — who is expected to sign it. What’s next? How about a condom that reads: “Warning: You may hate yourself in the morning”?
One way or another I’m gonna find ya, I’m gonna getcha getcha getcha getcha!
- Blondie, “One Way or Another”
In a break with Wall Street tradition, leading financials analyst Dick Bove, at Rochedale Securities, has issued a Sell on Goldman Sachs (12 May, Dealbreaker.com, “Dick Bove Isn’t Going To Mince Words On Goldman Sachs”).
Analysts live or die by their access to corporate managements, and corporate managements, like the army in Catch-22, want to be liked. And corporate managements — again like the military — like their analysts embedded. Like journalists who travel with the US Army, the analyst at the CEO’s table gets a ring-side seat on the corporate story. And also like the reporter, the analyst only gets to see what his embedders want to show him.
Wall Street analysts rarely go off on their own, because they live and die by Corporate Access — their cherished ability to get the CEO to take their phone calls. Thus, when a high-profile analyst slaps a Sell recommendation on a major firm, we have to assume it’s because the relationship has outlived its usefulness to the analyst. Let’s face it: nobody is so powerful that they can put a Sell on Goldman Sachs with impunity.
We won’t ask what tipped Bove that the game is up at Goldi. In the conflicted world of Wall Street one does not have to have a positive outlook on a stock to maintain a Buy recommendation. But there is a creeping sense on Wall Street that the game may be up in a more fundamental way. Wall Street often attracts the Best and the Brightest, but it also turns them into fatuous morons who believe no one else will be smart enough to catch them.
Enter potty-mouthed rock-star gonzo financial journalist extraordinaire, Matt Taibbi, whose series of pieces in Rolling Stone magazine have dissected financial and governmental dirty dealings with great precision and clarity. In preparation for his latest piece (Rolling Stone, 26 May issue, “The People V. Goldman Sachs”) Taibbi once again did something practically no “serious” financial journalist would deign to do: he actually read the (unfortunately not bestselling) book “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse”, the report of the Levin-Coburn commission’s inquiry into the causes of the financial crisis.
Senators Levin and Coburn have put together a book that is remarkable by Washington standards. It is bluntly forthcoming, explaining in detail a tremendous number of bad deeds, and naming explicitly a large number of bad actors. And it is surprisingly readable. The report is a roadmap to how we got to where we are today and should be required reading for every investor and every voter in this country. If enough people took its message to heart, perhaps Mr. Taibbi would see some of his more cherished — and unlikely — scenarios come to pass, such as sending Wall Street CEO’s to Riker’s Island where they could spend a decade suffering sexual abuse. The thing about Taibbi’s rants is, this is just the kind of thing that people really, really want to see happen. Suddenly, in the age of the Tea Party, tarring and feathering is looking like an option. Call it a groundswell. Popular anger can move mountains. It can certainly empty out the White House.
Just one quote from Taibbi’s latest piece will give you a flavor: he says Goldman marketed paper they knew would fail, and bet massively against it while claiming Goldman’s interest was aligned with the investors’ because Goldman “bought a tiny, $6 million slice of the riskiest portion of the offering. But what it left out is that it had shorted the entire deal, to the tune of a $2 billion bet against its own clients.” Talk about selling worthless securities with impunity — the ultimate naked short?
The Levin report should be read by anyone who receives this screed — it’s thorough, clear, and refreshingly candid. Taibbi’s reporting needs to be read for a different reason: there is an audience out there that has always been uncomfortable with standard industry mouthpieces like the Wall Street Journal. Many of them are intelligent and successful. Many of them own securities. They just don’t trust Washington, they don’t trust Wall Street, and they have never found an intelligent, informed and articulate voice that expresses their discomfort. Now they have. Dick Bove read Taibbi’s article. It looks like he got the message.
Members of the establishment press have called Taibbi an “autodidact” financial journalist, a backhanded compliment that implies a lack of clear thought process. The fact is, unlike other journalists writing about Wall Street, Taibbi refuses to be embedded. When they say he’s “self-taught,” what they really mean is he doesn’t parrot what Wall Street and Washington tell him. He tells it like it is.
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