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Kass: Blame Game Is Dishonest

Doug Kass

"The most nefarious aspect of the short sellers revolves around their concerted efforts to destroy, or at least diminish, the companies' existence as going concerns."

-- Marty Whitman, Third Avenue Funds' third-quarter 2008 letter

I am struck by the fact that such a large number of respected money managers have purchased huge positions in many of the financial stocks that have dropped so dramatically over the past two years. (Many of these have been analyzed and discussed critically on these pages as attractive short sales.)

I am also struck by the fact that so many of these money managers blame their ailing positions and poor overall investment performance on short sellers rather than on the inadequacy of their own research and analysis.

David Dreman (Dreman Value Management), Richard Pzena (Pzena Investment Management), Bill Miller (Legg Mason) and Marty Whitman (Third Avenue Management) have doubled and tripled down their ownership of Fannie Mae (FNM Quote), Freddie Mac (FRE Quote), Ambac (ABK Quote) and MBIA (MBI Quote) -- among other impaired financial intermediaries.

The confidence expressed by the above-mentioned managers in their ownership of shares of companies like Freddie Mac are especially stunning -- or frightening, depending on one's book. For example, Bill Miller reported holding about 50 million shares of Freddie Mac at the end of first quarter 2008 -- worth about $1.3 billion, or slightly more than $25 per share, at that time but purchased at a much higher prices. Last week, Miller announced that he raised his holdings in Freddie Mac during the second quarter by over 60% by adding 30 million more shares, bringing his total holdings to 80 million shares. Freddie Mac closed trading on Friday at $2.81 per share.

Under the circumstances, blaming the poor share price performance for a stock such as Freddie Mac on the purported iniquitous scheming and market influence of short sellers seems outside the realm of reality. It is for that reason (and others) that I penned my op-ed piece in the Financial Times on Friday.

"There is a certain measure of the moralist in short sellers. As detectives on Wall Street, they enjoy revealing the emperor without his clothes."

-- Kathryn F. Staley, The Art of Short Selling

Perhaps, it is as one of the hedge fund industry's icons told me years ago, "The value of a large investment organization is greatly over-exaggerated." It might also be that the above examples of "dip buying" represented an error in judgment and/or intransigence on the part of these great investors. Or, perhaps their outsized losses (both in dollars and on a percentage basis) were simply a function of poor analysis and then denial.

Whatever the reason, I can only talk from my own experience. Above all, when I invest, I try to be honest with myself, I critically test others' views (and the market's prevailing bias), I weigh changing fundamentals, and I attempt to employ a rigorous loss discipline.

As I wrote earlier, there are several common threads in the commentary of the chastened investors in Fannie Mae, Freddie Mac, Ambac and MBIA -- and that list can be extended Citigroup (C Quote), Wachovia (WB Quote), Radian Group (RDN Quote), PMI Group (PMI Quote), MGIC Investment (MTG Quote) and other financial stocks held in the portfolios of the Dremans, Pzenas, Millers and Whitmans out there -- as a large amount of money has been lost in these stocks, and the short selling community has become their scapegoat.

"This vast right-wing conspiracy has been conspiring against my husband since the day he announced for President."

-- Hillary Clinton

From my perch, considering the depths of the current economic problems, to blame the substantial share price declines in financial stocks on a short-selling conspiracy is as silly as the above quote from Senator Clinton.

I run a hedge fund dedicated to short selling. My goal is to deliver absolute returns in any market or economic cycle. Sometimes I achieve success; sometimes I meet with failure. I and other dedicated short sellers represent a small minority (estimated at less than $5 billion) within a hedge fund universe that approaches $3 trillion in assets under management and a mutual fund industry that exceeds $10 trillion in size.

I attempt to create a short book by identifying companies whose business models are exposed to changes in the competitive landscape -- often through new challenges like technology and the Internet. There are no short sellers I know of any consequence -- and I know most of them -- that rely on spreading rumors in order to move their targeted shorts lower in price. The short sellers I know rely on hard-hitting analysis. We have to because, over the long run, stocks rise in price.

Call me old school in my view, but investors ought to be accountable to their investment managers and corporations accountable to their shareholders.

Yale University Professor Owen Lamont once said, "When security prices are wrong, resources are wasted and investors are hurt." Wall Street does not produce (and never has) disinterested and objective research. They are in the business of selling products (stocks, bonds and, ugh, in recent years, derivatives). And Wall Street compensation has, for decades, been a "heads they win, tails they win" proposition.

Short sellers are our first line of defense against securities manipulators who would pump and dump worthless securities. It is important that the stock lending market work efficiently in order for the short sellers to be able to do their job. By preventing fraudulent manipulators from hyping overpriced stocks to the stratosphere, they can prevent investors from buying overpriced stocks.

-- Professor James J. Angel, Georgetown University

In summary, short selling is vital to the balance and functioning of the equity markets.

Investors (individual and institutional) must look into the mirror of honesty regarding their mishaps as playing the blame game card is unprofessional, dishonest and, quite frankly, is getting long in the tooth.

It's time to pay more attention to short sellers when their analytical arguments are well-reasoned and documented, so listen up.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass' daily trading diary, please click here.