Streetwise Professor

December 12, 2008

Convertibles, The Short Sale Ban, and the Near Toppling of Citadel

Filed under: Derivatives,Economics,Politics — The Professor @ 12:02 am

More detail on the havoc wreaked by that Mr. Magoo of American finance, SEC Chair Christopher Cox, and his short-sighted short sales ban:

The panic that swept through the capital markets after Lehman declared bankruptcy was one form of human frailty that Citadel’s sophisticated mathematical models could never have anticipated. The second and perhaps more devastating one occurred on Wednesday, Sept. 17, when news broke that the Securities and Exchange Commission was considering a temporary ban on short-selling 900 stocks – 799 of them financial stocks.

The proposed ban was good news for the banks and brokers. It meant that Morgan Stanley (MS, Fortune 500), Citigroup (C, Fortune 500), and others didn’t need to worry that hedge funds could drive them to the brink.

Yet the news was horrifying for hedge funds like Citadel. Scores of Citadel’s positions – particularly in convertible arbitrage, which requires shorting – would simply blow up if the ban went into effect.

According to sources, Griffin phoned Christopher Cox, the SEC’s chairman. Griffin pleaded with Cox, telling him the ban could mean certain death to many hedge funds – including Citadel. Cox, according to these sources, was unmoved and merely responded with the party line about how the country was going through a national financial crisis and the SEC needed to do what it had to.

There was nothing Griffin could do or say to sway him, and on Friday, Sept. 19, the ban was made official. (The SEC declined to comment for this story.)

Citadel was now hemorrhaging money. Over the weekend and throughout the following week, Griffin talked with his portfolio managers and told them to dump the dogs and keep the racehorses, meaning preserve the positions that they believed had long-term upside as they engaged in a selloff.

By the end of September, Citadel’s funds were down 20%. In early October, Griffin sent a letter to investors stating that September had been the “single worst month, by far, in the firm’s history. Our performance reflected extraordinary market conditions that I did not fully anticipate, combined with regulatory changes driven more by populism than policy.”

“The SEC needed to do what it had to.”   I sure hope that is nothing even close to a direct quote of what Cox told Griffin, for if that’s what counts as reasoned policy, we’re in even deeper trouble than I thought–and I thought we were in major trouble.

I guess it could have been worse.   He could have said “A man’s gotta do what a man’s gotta do.”

Print Friendly, PDF & Email

No Comments »

No comments yet.

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress