Choice. Just choice.
A bit old, but let us today linger for a moment on a story printed in the Pioneer Press on February 28 by banking and finance reporter Nicole Garrison-Sprenger, noting the fact that the “short interest” in the stock of U.S. Bancorp had nearly doubled between mid-January and mid-February — to 37.5 million from 20.9 million. It was the third-biggest change in shares in the period, according to Barron’s.
Wow, what a horrible thing! All these people — the Darth Vaders of the investment world — betting that the stock of the company was going to drop. (A short sale is a bet that a stock is somehow overvalued. To profit on such a trade, the short seller borrows the stock from a broker on behalf of an investor, then sells the borrowed stock in the open market at the current price. The idea is to return the borrowed stock to the broker down the road by buying the stock at, it is to be hoped, a lower price, pocketing the difference as a profit.)
One would have thought that the market believed the world was going to collapse any SECOND for this company. And the company reinforced it: U.S. Bancorp “did not offer anyone who could comment” on the situtation. Absolutely incredible. Why?
Well, back in December of 2005, U.S. Bancorp issued $2 billion in convertible debt. At the time, the company’s common stock was trading at just under $31 a share. The “strike price” of the convertible: $36.85 a share, meaning that the holders of the bonds have the right to convert the bonds into common stock once the stock reaches $36.85. Thus, when the converts were issued, they were more than $5 a share “out of the money.”
Fast forward to February, 2007. U.S. Bancorp (NYSE: USB) stock is on a tear, trading to a 52-week high of — you guessed it — $36.85 a share. How about that.
Welcome to the world of hedge funds — pools of loosely regulated private funds that pursue a wide variety of strategies, including the shorting of stocks.
The last figure I saw put the number of hedge funds at 8,600, with well over $1 trillion of assets under management. An even more important statistic is this: more than 120 hedge funds are focused on (surprise): convertible bond arbitrage. The idea of convertible bond arbitrage is that the investor buys the convertible bonds of a company and sells short the common stock of the company. This strategy — it’s called a delta hedge, but we won’t get into that — becomes especially relevant when the convertible bond is trading near its strike price.
What’s interesting about this is that the bet here isn’t necessarily on the common stock falling, but rather on the potential for high VOLATILITY in the underlying shares and convertible bonds. That’s because, based on the hedge ratio used by the manager, the arb can profit from movements in either the convertible bonds or the common stock.
The point here is this: U.S. Bancorp could have defused this whole story by explaining this to the reporter. The short interest had less to do with a negative bet on the company’s future, but on a complex trading strategy that had more to do with the potential for volatility in the stock.
Shame on you, U.S. Bancorp. Dumb. Dumb. Dumb.
The Same Rowdy Crowd 
And doesn’t journalism compound the problem?
How many reporters actually get this stuff? Tony, you’ve studied like hell and gotten a bunch of letters to put after your name on your business card so you understand this — and the Pioneer Press reporter may as well.
But when reporters who don’t know as much as you know oversimplify, and add “objectivity” to the mix, they tend to say first-level stuff: “Short-sellers are buzzing around US Bancorp stock, thinking it’s going to drop.” That story is bad for the bank’s reputation (the poor dears).
What reporter will write, “The buccaneers of hedge funds, who play with the economy like crack dealers play with lives, are swarming around US Bancorp stock, speculating that the behavior of other pirates will shoot down the stock even though that dip in the numbers has absolutely nothing to do with how well or poorly the bank is doing business. They’re probably going to make some money for people who already have an obscene amount of it, but they’re going to scare regular-Joe investors who are looking for a bank that does business well and gives a decent return.”
Most reporters don’t know enough to decode things the way you do, Tony, so journalism passes along, uncritically, the language of Wall Street in neutral tones, calling this activity investing rather than calling a spade a spade and saying it’s the kind of speculation that tanked this country in the Gilded Age and the 1920s.
Do these hedge fund manipulators add a single jot of value to the economy? Or are they just rolling dice at the foot of the cross?
Apparently I’m pissed at capitalism today, and at the journalists who enable its distortion to stack the deck for those who get bonuses bigger than the total salaries of 100 of their workers.
Workers of the World Unite.
Yes, Bruce, you’re right. But the vast majority of the blame in this instance has to sit squarely in the lap of the PR department at USB. Business can’t expect reporters to know this stuff, but we can expect business to know it about themselves, and to be able to explain it to the rest of us.
Why shouldn’t reporters be required to know this stuff? If not, they shouldn’t be writing about. Even to simplify a complex topic, you should know what you’re writing about! Don’t blame USB for this one–they probably can’t comment due to SEC rules.
J.S.: I’m a big, big proponent of the idea that reporters need to know more than they do, but I’m not sure they can be expected to know about these sorts of trading strategies. As for USB, I don’t know of any SEC rule that would have prevented the company from offering the trading strategy as one of several possible explanations for the jump in the short position. Not saying anything is like not explaining why a stock drops after it goes ex-dividend.
In a general sense, it’s a disservice to investors not to try to offer a reasonable explanation for the trading activity in their shares if such an explanation is available. Companies pay $30K and up per year for shareholder “surveillance services,” where firms will track DTC codes to provide a reasonable guess to the company about who is buying and selling their stock.
Exactly. If the journalist doesn’t know about it something it should be noted or a new journalist found…
R