Archive for the 'short sell' Category

Date: July 16th, 2008, Filed under short sell, stocks, SEC

Chicago, IL
By A.B. Dada
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There’s a phrase I like to use, often, when it comes to government ineptitude. It’s called a “self-fulfilling prophecy.” I’ve found out how to create these myself. If I ask a person not to do something that isn’t even on their mind, they’ll end up doing it. Much of what government does to try to hide the truth ends up making the problem even worse as people realize the game played by the powers that be.

The SEC today is creating such a self-fulfilling prophecy. As of Tuesday, July 15th, the SEC has created a new rule to prevent short-selling bank stocks. Some of the stocks that can’t be short sold are Lehman Brothers, Goldman Sachs, Merrill Lynch, Morgan Stanley, JPMorgan Chase & Co and Citigroup Inc. There are a total of 19 financial firms that can’t be legally short sold.

Many people do not understand how short selling works. In simplest terms, a short sale is basically betting that a stock will drop in a certain period of time. It’s a very risky gamble, because stocks tend to go up just due to new money being created by the Federal Reserve. Here is how a short sale works, in still simple terms:

Let’s say you believe a bank’s stock, currently at $100, will drop to $80 in 3 months (October 16th). To short sell that bank stock, you go to the market and opt to “borrow” someone’s share of that stock, with a promise to pay them the stock back on October 15th, regardless of the price. If the share is $100 now, you pay a small fee to borrow that stock. On October 16th, you settle it by returning the stock to the original owner. Once you have the borrowed stock, you can sell it immediately for the current value, again say $100. When October 16th rolls around, you must buy another share of that stock at the current market value, and return it to the original owner you borrowed from. If the share is $80 on October 16th, you pocketed $20 profit in 3 months. But if that share is $120 on October 16th, you’re out $20 plus the fee you paid to borrow the stock. Dicey and risky, but in a declining market it can be very profitable.

Many false economists, such as all those who work for the government, believe that short selling speculation can crash a stock. If too many people are trying to short sell a stock, the market believes that stock is about to crash in price, and some believe that shareholders will sell it off early to resist a fall in price. As more people sell a stock off, the price does tend to go down. They want to blame that on short selling, rather than blame it on a weak corporation.

Here’s the problem: if a bunch of short sellers collude to drop the value in a stock by causing fear, it opens the door for wiser and more researched individuals to buy the stock at a discount, and when the corporation’s “problems” are realized to be non-existent, the shareprice will return to its previous value. With millions of people buying and selling stocks, short sales tend NOT to cause damage to the reputation of a company. Unless that company is truly in trouble, as we saw with IndyMac’s share price.

With the SEC releasing the names of the 19 organizations who traders can not short sell, the SEC is creating a self-fulfilling prophecy. By saying “there is nothing to see here, but you can’t short sell,” they are telling people that there ARE problems with those stocks. This may cause a sell-off of the stocks the SEC is trying to protect.

If you’re in those banking stocks, I’d be weary of any movement, positive or negative. By reducing your freedom to bet against the stock’s future, you’re being restricted in how you can handle your stocks today. It’s hurting you even if you think the stock will go up: in a case where you feel the stock will go up and someone else thinks the stock will go down, you can profit even nicer by offering your shares to a short seller in exchange for their borrowing fee.

Don’t look at what a government agency such as the SEC says, look at why they do what they do. Even they have no faith in banking stocks.

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Date: December 10th, 2007, Filed under mortgage, foreclosure, bankruptcy, short sell, Dave Ramsey

Zion, IL
By A.B. Dada
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While watching the Dave Ramsey show last night, I caught one caller’s question and I definitely had a agree/disagree scenario over what Ramsey recommended to the caller.

The gist of the caller’s problems revolved around the caller losing their job (making $250,000 per year or so), but having a large mortgage payment. The caller believed that their home was worth $1.2 million, although I’m not sure how the caller came up with those figures. With property values falling in most areas, going by recent appraisals or even worse by Zillow’s figures can be very wrong. The caller said he owed $900,000 or so on the mortgage, and was hoping to acquire a new job at significantly lower income (in the low $100,000 range if I remember correctly). The caller had about $150,000 invested in stocks, and ask Ramsey what he should do to ward off foreclosure.

Ramsey’s advice was to sell the stocks and put the money towards paying off the loan while the caller was still unemployed. To a point, I do agree with Ramsey: if you took out a loan, you should take every step possible to make good on your promise. I find bankruptcy very immoral in most situations, where people have other opportunities to pay back their promises, such as selling other assets, getting a second job, and reducing spending. For many people who borrowed a mortgage in the form of a toxic loan, the likelihood of a short sale and even a bankruptcy is reality, but that still shouldn’t meant that they take the immoral route before looking at other options.

I do disagree with Ramsey on some other notes. In many areas, renting a home can be far cheaper than borrowing to own one eventually. When a house’s price is more than 120 times the monthly rental, owning is usually a worse position. Once you add in the cost of taxes, insurance, and upkeep/maintenance, it becomes obvious that homedebtorship is a losing proposition, especially in a market where the price of the home is decreasing as each day passes.

My opinion, and order of operations, for the caller is this:

1. If the caller truly has equity in the home, they should sell it immediately, pricing it at the bottom of the market of comparable properties, to move it quickly. Whatever equity they end up with (meaning, any money left over after selling the home, paying commissions, and paying off the mortgage) should be placed in a savings account to pay for future rental expenses.

2. Upon selling the home, the caller should rent immediately. During the moving process, they should also sell assets that wouldn’t be used while they are renting. I would also advise the caller to rent a home or condo smaller than they currently use, even possibly slightly smaller than they believe they need. The caller should also locate a neighborhood that is close enough to where they hope to work, but far enough away that they can save money even over the added cost of gas and time spent driving. The caller might be shocked that they could rent on their same street or in the same neighborhood as their current home is in for a fraction of the cost of borrowing, once you consider the tax/insurance/maintenance costs associated with living in a mortgaged property.

3. The stocks should not be touched if the caller can extricate themselves from the home. In the event that the caller can not sell the home for the value of the mortgage, only then should the stocks be sold to pay the difference, plus a little extra to pad a savings account with at least 6-12 months of the total cost of renting a home or condo. The total cost of renting should include the security deposit (registered as a savings account in their budgeting and accounting software), renting costs, insurance, and utilities. By providing for a safe living arrangement, the caller can then focus on acquiring a job, or better yet two, to get back to financial prosperity.

4. In the event the the caller can not sell the home for the payout of the mortgage plus their stock value, the caller is in trouble. At this point, making a mortgage payment out of their stocks will still have them upside down on their total equity. Only in this case would I agree with Ramsey that the caller should liquidate their stocks equal to 12 months of mortgage payments, insurance, maintenance and utilities, and work to find a job that can pay more than those amounts.

5. In no situation would I recommend bankruptcy or a short sale, as this pushes away the moral responsibility to paying their debts. If the caller ends up liquidating all their stocks and then running out of money, only then should the caller inquire to what they can do to resolve the situation as morally as possible. In some cases, the bank may allow a short sale if the caller also acquires a personal unsecured loan to pay back the difference between the mortgage payoff and the short sale figures. I highly recommend working out a payment plan for any difference in a short sale — anything less is an immoral procedure, one that can and should riddle the borrower with guilt for ripping off a bank and the depositors that funded their loan.

While I admire Ramsey, I believe some of his recommendations ignore other obvious first steps that should be taken, as I lined out above. He jumped to step #3, rather than look at the first two steps as an obvious and more moral solution that should reduce the long term risk of staying in a home with possible equity.

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