Then Steve H., a regular correspondent and fellow skeptic dropped me an email with the following off of www.minyanville.com.

Two Plus Two Equals Four

Financial companies are desperate for capital, but their stock prices are so low that any issuance would be dilution death for the companies. The government is desperately trying to keep the financial system together. Add that up and you get the possibility of a great manipulation.How would the government engineer a rally in financial stocks so that these companies can sell stock to raise capital at a reasonable or at least palatable dilution level?It might go something like this. Since financial stocks are in such trouble, they have heavy short interest; this is natural and well known and can be used to their advantage. A clever “berry” might think to introduce confusing rules that raise the cost of borrowing short stock and temporarily confuse shorts into covering and not shorting more. And this is precisely what the SEC did.

It seems innocuous to most folks, but it put stock loan desks and dealers in complete disarray. New short sellers could find no stock to borrow and many existing short sellers were forced to cover as the technical rules forced allocation of loans at much higher costs.

For example, the rebate rate on Fannie Mae (FNM) the day before the SEC announcement was 1%; the day after it was -5%. Many who were short the stock were forced to cover, thus driving the stock price up.

But this alone would only drive stock prices up so much. The clever berry needs a catalyst, one that would force panic buying into now truncated supply.

It just so happened that the new SEC rules came conveniently the day before many of these financial companies were to report earnings. If just somehow these earnings were really good, the match would be lit on the kindling.
So far banks have miraculously come through on their end of things. Wells Fargo (WFC) and JPMorgan (JPM) reported better-than-expected beaten-down earnings. Things must be getting better just as the companies need capital.

What a coincidence.

But if you look at how the banks “beat” their earnings, the coincidence becomes clear. WFC took the unprecedented step of extending charge-off acknowledgment from 120 days to 160 days. This allowed the bank to move less capital to loan loss reserves and report better-than-expected horrible earnings. And JPM was even more aggressive. It actually lowered its loan loss reserves quarter to quarter.

The list of financial companies where shorting regulations are being enforced/enhanced is precisely the banks and dealers (and FNM/Freddie Mac (FRE)) that have access to the Fed’s balance sheet (dealers through the PDCF and FNM/FRE through the recently allowed access to the discount window). So we can speculate on the nature of the ”coincidence”: Perhaps the Fed is getting worried about the value of all that collateral these dealers have posted to the Fed balance sheet and must boost the capital of these companies to protect that value.

And now on cue FRE, a $5 billion market capitalization company wants/needs to issue $10 billion in new stock? Doesn’t that sound a little crazy? Well, get ready for others to do the same because the banking system needs capital desperately and the government is there to help.

But help at the expense of whom?

And the Minyanville contributors are not the only ones noticing what’s going on… just today The Economist published the following commentary that (accurately) paints the SEC in a less-than-favorable light.

America’s SEC fights dirty

BEAR markets often involve bare-knuckle fights, but it is still a shock when the referee starts punching below the belt. The Securities and Exchange Commission (SEC) has intervened in the epic struggle between financial companies and the hedge funds that are short-selling their shares.

Desperate to prevent more collapses, the main stock market regulator has slapped a ban for up to one month on “naked shorting” of the shares of 17 investment banks, and of Fannie Mae and Freddie Mac, the two mortgage giants. Some argue that such trades, in which investors sell shares they do not yet possess, make it easier to manipulate prices. The SEC has also reportedly issued over 50 subpoenas to banks and hedge funds as part of its investigation into possibly abusive trading of shares of Bear Stearns and Lehman Brothers.

The SEC’s moves deserve scrutiny. Investment banks must have a dizzying influence over the regulator to win special protection from short-selling, particularly as they act as prime brokers for almost all short-sellers. There is as yet no evidence that market abuse has driven down financial firms’ share prices—and plenty that their trashed balance-sheets and credibility have. London’s financial-services regulator has as yet failed to provide evidence to justify its decision to tighten the disclosure rules on short-selling of some bank shares.

The SEC’s initiatives are asymmetric. It has not investigated whether bullish investors and executives talked bank share prices up in the good times. Application is also inconsistent.

          Editors Note: The Room is brought to you weekly by David Galland at Casey Research 

Read the Full Article

Source: The Room Monday, July 21, 2008

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Pages: 1 2