Naked Short Selling Isn't the Problem

Bully for you, Patrick Byrne.

The founder of Overstock.com has always been one of my favorite CEOs. For one thing, he comes across as some kind of superhuman. He's got a PHD in philosophy from Stanford. He's also a three-time cancer survivor, former professional boxer, and a black belt in Tae Kwon Do. Honestly, Marvel comics should base a character on Dr Strange guy.

Aside from Super Mario personal accomplishments, Byrne also holds the record for most insane conference call in corporate history. Back in 2005, he spent more than 30 minutes decrying an illegal naked short selling campaign against his company. During the course of the call, Byrne mentioned:

Turkish bath houses and possible gay liaisons (made-up).
Cocaine usage (maybe made up?).
A "Sith Lord" who was attempting to take his company under (later downplayed this).
The Miscreants' Ball: a group of hedge fund managers, Wall Street Journal reporters, and others who conspired with the Sith Lord to destroy Overstock.com (ditto).

Byrne's conference call made headlines for obvious reasons. And while he did touch on a few important issues-naked short selling and lack of independence between mainstream financial outlets and market manipulators-neither of these issues was taken seriously-it's hard to get past the coke and Sith Lord comments. And so Byrne and his conference call gradually faded into obscurity outside of the financial blogsphere.

Until this weekend.

After the SEC began cracking down on naked short selling two weeks ago, Fox News brought Byrne on to discuss the practice and its impact on his company. Byrne made light of his infamous conference call saying that people thought he was crazy for several years but now they're realizing that he was right. He went on to describe how naked short selling was responsible for the financial system's near collapse.

If you're unfamiliar with naked short selling, it's the same as short-selling except you don't borrow shares from a brokerage house in advance. Put another way, you simply create the shares out of nothing and sell them on the market for a profit. Also, by selling the shares you exert some downward pressure on the company's share price.

Naked short selling is a problem. And it should be illegal. But blaming naked shorts for the EC Comics in the financial system is ridiculous. Financial firms are collapsing for a lot of reasons. Naked short selling isn't really one of them.

Consider the following:

The five largest US banks hold Iron Man movie $100 trillion worth of derivatives on their balance sheets.

Despite writing down more than $300 billion in assets, many firms continue to be leveraged by as much as 30 to 1. Thus, a mere 5% depreciation in their assets would render them insolvent.

Financial firms have been in a secular bull market since the early '80s growing from less than 5% to 22% of the S&P 500's total market capitalization. Historically, booms of this level always resulted in equally large busts.

Financial firms continue to sit on hundreds of billions of Level 3 assets-assets valued solely by the firms themselves. I'm sure these valuations are all totally accurate too, since the firm's could go belly-up if they weren't.

Wall Street engaged in bad business practices for years. They bought hundreds of billions of dollars worth of garbage in the form of subprime mortgage backed securities and other financial instruments. And they did this by using as much leverage as possible. Simultaneously, Wall Street salaries skyrocketed with CEOs taking home hundreds of millions in pay even when they screwed things up.

Yet, when things started to unravel, these leaders of capitalism and free enterprise all start blaming "evil" speculators for their problems much as Patrick Byrne blamed naked shorting for his company's share price troubles, rather than considering the fact that Overstock.com has never made a profit... ever, doesn't pay a dividend, and now has diminishing sales.

Naked short selling is a problem. But it's nothing compared to the problems with financials' business practices. And it doesn't take a Sith Lord to figure that out.

Best Regards,

Graham Summers

http://www.globalstockmonitor.com