Bill Fleckenstein of Fleckenstein Capital appeared on CNBC last Friday. For those of you who have followed Bill's work and recall his consistent hammering of the poor quality of the information available on the network -- which he routinely calls "Bubblevision" -- you'll instantly recognize the irony. But Fleckenstein was on to talk about the SEC's new Regulation SHO, which is designed to prevent some of the shenanigans related to "naked shorting," a back-office move that essentially allows traders to short shares of a company that they have not legitimately borrowed.
I'm opposed to any and all such shenanigans, and as such support the thrust of Regulation SHO. But I'm troubled by what has become a refrain surrounding the need for this regulation: the thought that when companies collapse it's because short sellers have "taken them down." This has a positive and a negative connotation. Short sellers like Jim Chanos at Kynikos Investors are credited with "bringing down" Enron with their questioning of the books. That Enron's collapse may have been precipitated by the sharp questioning and analysis from Chanos isn't the point: His analysis seeded the doubts and caused others to investigate.
But Chanos didn't destroy Enron; Jeff Skilling, Ken Lay, and the dozens of crooked folks atop the company did, along with their professional handlers. Chanos didn't create the accounting mess; He uncovered it. Short sellers profit on company problems that haven't yet come to light. They naturally are pretty pleased when they get it right, but it doesn't mean that they should be blamed for the company's collapse.
Again -- what we're talking about here with Chanos is legitimate analysis. Bozos like Walter Piecyk from Fulcrum Partners, who this past week paid a fine for spreading false rumors about RF Micro Devices (NASDAQ:RFMD), all while holding a short on the company, deserve the Holy Grail treatment: Have bridges built out of them. How much money has that guy destroyed between his brazen, cynical $125 per share (split-adjusted from $1,000) Qualcomm (NASDAQ:QCOM) price target at the tail end of the bubble and his rumormongering on RF Micro? There's someone who should get a little more blame: Folks who actively tried to impact share prices for reasons other than fundamental strengths or weaknesses.
The trouble is that there is so much addle-headed commentary out there, with journalists even at the biggest and best papers -- not to mention the news readers at the CNBCs of the world -- placing blame where it should not go. If Krispy Kreme (NYSE:KKD) collapses, it will have nothing to do with the fact that some folks have been saying that management has been diddling shareholders for years, and much to do with the fact that there was actual diddling of shareholders going on in the form of repurchased franchises, bad decisions, and what can only be described as equity abuse. Short sellers didn't hasten now-former CEO Scott Livengood's pursuit of other, uh, pursuits, and they didn't make the company's shares drop more than 80%. They didn't put the company in danger of missing its financial covenants, and they didn't create conditions where Krispy Kreme's annual report should come with a "do not resuscitate" warning. Management did, and starry-eyed shareholders who really, really wanted to believe did. Wanna know why the first group did it? Because the second group exists, that's why.
Trying to protect something that doesn't exist
All of this is a preface for me to make fun of a group that is cynically trying to blame the wrong people for its own gain. In this case, I note the comments that the National Association of Home Builders made over the weekend about the risk to the housing market that congressional, regulatory, and White House moves to restrict Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) would cause.
Specifically, the homebuilders association -- which includes among its members giants such as NVR (AMEX:NVR), Pulte (NYSE:PHM), Toll Brothers, and Lennar -- stated that it would oppose any steps that would undermine the federal government's "implied guarantee" of Fannie and Freddie's debts. They claim that any uncertainty over government backing of these two companies (I explain how Fannie and Freddie work in this article) might cause mortgage rates to rise. Homebuilders naturally root for lower mortgage rates because they have the stimulative effect of making it possible for home buyers to get more house for the same monthly mortgage expense, all else being equal.
So the homebuilders, interested in protecting what has been a milk-and-honey kind of market for them over the last three years, said that they would oppose any move by the federal government to put into place a plan of receivership for the two companies should they go bankrupt. Yes, it is baffling that there is no such procedure in place should one or both -- with their $1.7 trillion in debts -- go up against the wall, but the fact that no receivership provision exists lends credence to the implication that the U.S. government -- your tax money -- will cover those debts should the disaster take place.
Ah, but prospectuses for Fannie Mae's debt offerings clearly state that the U.S. government does not provide backing. So why in the world would the homebuilder association -- as well as new Freddie Mac CEO Richard Syron, who attended the association's event -- make speeches warning that there would be disastrous consequences should the level of backing by the government be clarified?
It's a confusion that Fannie and Freddie have a pecuniary interest in maintaining, as both have been able to play both sides of the fence, claiming independence when it behooves them all while encouraging the belief among the public that they have the implied backing and full faith and credit of the government such that their debt is safer than AAA-rated bonds. Executives from Fannie have said as much in letters to the government without having received corrections.
So now that both Freddie Mac and Fannie Mae have been embroiled in multibillion-dollar accounting scandals, their wingmen at the NHBA are ringing the Klaxon that any government clarification on its relationship with the two companies that includes provisions for receivership instead of the implied bailout would harm homeownership.
Such bellyaching ignores that the threat to the home market was ultimately caused not by the government, not by regulators, but by hubris, cheating, and a sense of invincibility among the folks running Fannie and Freddie themselves. The $9 billion restatement at Fannie wasn't caused by the government, nor was the fact that the company had to cut its dividend and sell billions in preferred shares to try to regain compliance with its (lax) minimal capital standards.
No, Fannie Mae and Freddie Mac had a pretty good thing going: They pretended that the government would back them in case of crisis, and the government decided not to correct them. But it wasn't good enough for those running the show, whose personal fortunes were tied not so much to performance of the companies' charter -- to provide affordable housing to poor folks -- but rather to the charter of Wall Street: increasing earnings per share. There should be no question that either company succeeded in this regard, but the lack of control, internal and external, and the quest for still greater returns was the cause of a great downfall.
Think about this: A few weeks ago, Fannie Mae had to sell $5 billion in preferred stock, and yesterday it announced that it had cut its dividend. These came as a result of the company's failure to meet capital standards as well as accounting standards. As a sacrifice, CEO Frank Raines and Chief Financial Officer Tim Howard were ousted, but the former will receive an $111,000 per-month pension for the rest of his life, pending an investigation. That's the penalty you pay for accounting fraud in America.
After decades of pliancy, finally the government and regulators have seen enough, and are seeking to place limits on Fannie and Freddie, including defining their responsibility in case of a default on debt. The homebuilders are warning the government about the consequences of such limitations. In any legislative fix, such potential consequences should of course be considered carefully. But that this discussion is going on at all is directly due to the avarice that took place at Fannie Mae and Freddie Mac. These two companies had all of the friends in the world in the halls of power in Washington and New York, and still managed to blow it.
It's not the regulators who are to blame for the changes that are inevitably coming for Fannie and Freddie and how they operate. It's not the short sellers who are to blame for saying that these companies are powder kegs that could explode. It's the folks who were in charge, running these publicly chartered entities as if they were independent fiefdoms to which the finger should point. If the environment for mortgage-backed securities changes, it is because they took the sweetest deal in the world, and ruined it.
Bill Mann owns none of the companies mentioned in this story. The Motley Fool is investors writing for investors.
