Lehman Brothers’ Short Selling Lesson

Chidem Kurdas

Share prices are now high by certain standards. Some are ripe for shorting, at least in theory. But in practice short trades are almost guaranteed to lose money in a rocketing market.  Short-biased hedge funds lost money in the past 12 months and short selling fell in December as stocks climbed.  

Short selling is not only difficult under most market conditions, it also a perennial target for angry corporate executives. Thus Lehman Brothers’ last chief executive Richard Fuld blamed short sellers for spreading malicious rumors about the bank.

As the endgame approached in 2008, Mr. Fuld became obsessed with short sellers. By the time he finally confronted the bank’s real problem and desperately tried to find money or a buyer, the game was already up.  Andrew Ross Sorkin tells the tale in Too Big to Fail (Viking Penguin, 2009)—-a book with a useful story, though bloated and dull in places.

Fuld comes across as a flawed man who made horrendous mistakes, but honest and a tragic character in the Shakespearean sense. Part of the tragedy is that he blames the messengers. Lehman made too many leveraged bets to survive intact the severe contraction in credit. Did short sellers spread malicious rumors? It did not really matter.

But Fuld repeatedly tried to get regulators to stop the short sellers. Another part of the tragedy is his pathetic penchant for expecting the government to save his company. Since the government shored up Bear Stearns earlier that year, nobody was willing to provide a massive infusion of capital without similar backing. But the US Treasury and the Federal Reserve chose not to do the same with Lehman.

Later, Fuld testified in Congress and said he woke up every night wondering, “what could I have done differently?” He would have had a better chance had he paid attention early on to the short sellers and raised money when it was possible to do so. Short sellers are usually correct in their assessment of company finances.

But when a market boom lifts all boats, even leaky ones, short selling shrinks, as it did this December. It’s a tiny part of the market anyway and easy to ignore—a dangerous temptation, sort of like driving through red traffic lights when you’re in a hurry.

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