Monday, November 17, 2008

The man inside, Bill Fleckenstein, founder and president of the firm, is a short seller and proud of it.

Mr. Fleckenstein, 55, has emerged as one of the most outspoken defenders of what has been depicted by everyone from the chief executive officer of Morgan Stanley to the Archbishop of Canterbury as a renegade class of investors. Since world markets began their most serious plunge in decades in July, 17 countries have banned or restricted short selling, including the U.S., Canada, United Kingdom, Germany, France, Switzerland, Australia, Japan and Taiwan. Commentators around the world have labeled short-sellers as hyenas, jackals, vermin and vultures.

Mr. Fleckenstein says that investors who bet that stocks will decline, as short sellers do, are simply bears. He says they are not to blame for the market meltdown.

“Short sellers didn’t lower the Fed funds rate or tell people to take out mortgages when they shouldn’t have,” he says. “Now we are the bad guys.”

The long-haired Seattle native is one of a corps of pessimistic investors who have been blamed for market manipulation since the 17th century.

The recent attacks began with the collapse of Bear Stearns Cos. in March. After the firm agreed to be absorbed into JPMorgan Chase & Co., Bear Stearns Chief Executive Officer Alan Schwartz told Congress that the firm was toppled by rumor mongering and abusive trading - often euphemisms for short selling.

After Bear Stearns’ demise, each new crisis in the banking sector raised alarms about short selling. When the share price of Morgan Stanley dropped sharply on Sept. 17, Morgan Stanley Chief Executive Officer John Mack declared in a memo to his staff, “Short sellers are driving our stock down.”

In Britain, the campaign against short sellers also goes back to March, when the Financial Services Authority said it suspected that “false rumors” linked to short selling led to a sudden drop in the share price of HBOS PLC, the country’s biggest mortgage lender. An FSA investigation found no evidence of abuse.

In September, when Lloyds TSB Group PLC agreed to buy HBOS for a fifth of its value a year earlier, both Archbishop of Canterbury Rowan Williams and Archbishop of York John Sentamu continued to blame the short sellers, with Archbishop Sentamu calling them “bank robbers.” (The 2007 annual report of the Church of England shows that its $8.75 billion of assets included a $51 million position in HBOS.)

The short sellers say they are scapegoats for the real villains in the meltdown.

“The shorts who warned about the real estate bubble have been proven right,” Mr. Fleckenstein says. “They’re blaming the shorts and bailing out the ones who lost all the money and almost took the financial system down.”

Most academic observers say the power of short sellers is overblown.

“In the current crisis, shorts are like flies on a carcass on the side of a road,” says James Angel, a finance professor at Georgetown University in Washington who studies short selling. “We should focus on who or what killed the animal.”

The short sellers have marshaled statistics to their cause. According to Short Alert Research, a Charlotte, N.C.-based firm that produces research for short sellers, from early July to late September short interest in 33 investment banks and brokers plunged by 33.3 percent. Yet, share prices still declined.

“It was the longs getting out,” says Mr. Fleckenstein. “Probably the insiders.”

Mr. Fleckenstein declines to disclose either the size or returns of his fund. He places most of the blame for the crisis in housing and mortgage-backed securities at the feet of former Federal Reserve Chairman Alan Greenspan. Mr. Fleckenstein has written a book on the topic called “Greenspan’s Bubbles.”

During three years starting in January 2001, Mr. Greenspan and the Fed slashed the Fed funds rate to 1 percent from 6 percent. Mr. Fleckenstein says it was this extremely aggressive monetary policy that led to the housing bubble and mortgage-market abuse.

Mr. Fleckenstein says that his research shows that mortgage defaults took their first sharp jump in February 2007 but that few leaders in either the government or financial industry sounded an alarm. “How inept are our leaders when they missed something so obvious,” he says.

Like his fellow short sellers, Mr. Fleckenstein sees no profit in optimism. He told Bloomberg News on Sept. 24, when the Dow was at 10,825, that he expected it to bottom out at 8,500. The Dow sank as low as 8,176 on Oct. 27, before rebounding. Mr. Fleckenstein insists, however, that it gives him no joy that his grizzly bear’s “Dow 10,000” hat is now out of date.

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