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Cramer's Rewrite of His 'Anatomy of a Shakeout' Column

The trader goes behind the scenes to explore the showdown in the dot-com world.
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This piece generated by far the most emails, as people seem fascinated about this behind-the-scenes showdown in the dot-com world. I want to rewrite it particularly with an eye toward learning how to sell better. People who didn't sell their dot-coms saw declines of 50%, 60%, 70%, and in some cases 80%. That's simply too much of a decline. It is NEVER worth riding things down like that. We are not talking about normal, garden-variety declines. We are talking about declines that have to be avoided like the Bubonic Plague.

So when does the repo man finish? (

I call him the repo man. In technical terms, this is a misnomer. The actual name for the person at a brokerage house who takes back, or repossesses your stock holdings bought with borrowed money is a "margin clerk." When I worked at Goldman Sachs (GS) in the '80s I knew all of the margin clerks because they are at the heart of a vast and largely misunderstood network of people who are in charge of giving you credit to buy things at brokerage houses. (These are THE key people, because many times customers want to borrow money to buy stocks, and these are the people responsible for being sure that the firm is repaid. Remember, the brokerage industry is a great money maker because there is no inventory to speak of. You pay or you don't get your stock. You may think that the brokerage houses get most of their money from commissions. But actually they make a ton of money by lending money out against stock to you for you to buy. They also make money on the credit balance you keep at their firm. Where they lose money is if you borrow money from them against stock as collateral, and that collateral goes down incredibly fast, so fast that you are inclined to walk away from your purchase, leaving them on the hook. Then the brokerage house has inventory and it never wants it. It never wants to wager that the stocks it gets stuck with go up. That's a bad bet. So it cuts its losses instantly. (That's what a margin call is, and margin clerks administer them directly to the brokers who handle the accounts. So when stocks go down, people who use those stocks as collateral get margin calls. That means they either put up fresh capital or they get sold out. I typically don't borrow a lot of money to trade, but I have had a couple of margin calls. They scare me because I can't go back to my clients and ask them for more capital, that's not cricket. So I have to sell when I get them, and I have had a couple of them. If I didn't sell, even though I have been a good client for Goldman, the margin clerk would sell me out. You never win a fight with a margin clerk. Never. That's why I call him the repo man.)

When does the forced selling in the Net end? Isn't that the toughest question? Let me tell you why it is so hard to determine, and why it is so open-ended.

(There is no magic to knowing when it ends. I have a ton of sources all over Wall Street but nobody gives up this stuff because it would be very unwise for a margin clerk to reveal that his firm is closing out a bunch of peoples' accounts. But I know what forced selling looks like and I know that margin calls are often behind it. I know it because I saw this kind of selling both as a broker and as a client. Often in these columns I am asked about what sign or machine or system I use to find out things. I always try to be polite when I say that I intuit them. But for me these questions are like "how did you know not to swing at that pitch?" when you are talking to a pro baseball player. It is my job to know; it is my job to have that judgment and I have practiced at it for a good part of my life. I am giving you the insight because I want to and that is my choice to.)

First, there are more margined players than ever and they are housed with brokerages that are new to the game. There seems to be more forgiveness and more leeway given to the indebted players this time than I can recall in previous years.

(When I worked at Goldman Sachs I knew all of my clients really well. I had only one really contentious margin situation, but that was simply horrible. I had to sell someone out of a biotech stock. If you look at the chart of that stock over a 15-year period you will see where I forcibly sold a chunk of stock to meet a really nasty margin call after my client repeatedly lied to me that he was sending the money in for his stocks that could no longer be covered by his collateral. (It was truly bloody but I was acting under strict orders. These days I get the sense that there is a bit more laxity to the process in part because of electronic trading where the client is pretty much of a wild card and in part because these day trading houses seem to have their own rules about how much a client can borrow because they seem to want to encourage trading. So it is harder than ever to figure out when people have to be cashed out. It no longer seems cut and dried.)

Second, the players who are margined aren't biting the bullet as I would have expected. It is almost as if they don't know how to sell, so the selling is being done for them by brokers, a la that example I just outlined. So the selling is done piecemeal and terribly.

(How do you sell? You sell when you can, not when you have to. If you see your collateral disappearing don't go into the cookie jar or the kid's piggy bank. Sell. Get out. Raise cash. You can't play that way and still make money. You are just a desperate gambler. Get liquid. Do it before the firm does it for you. I am no Puritan but margining to your eyeballs in a down tape is just plain stupid. Don't email me and tell me otherwise. You don't know what you are talking about.)

I don't want to use individual stocks, as it is too supersensitive, but the average

stock is going down on 400 and 500 share lots that are being tossed from one poorly capitalized agent to another. Nobody is able to put anything to way. NationalGiftWrap and hot potato is more like it. So a $40 stock goes down seven points on 4,000 or 5,000 shares.

(Again, the landscape has changed from when I was on the sell-side, or the brokerage side. There are many, many small players in the game. These small players sell electronically and there is no place to put their stock. So stocks are going down on what is known as "nothing." I saw stocks trade down this week on so little stock that sometimes it was just the same 500 shares going from dealer to dealer to dealer, each one taking a little loss until the stock finally closed for the day. No one knew where to put the stock. The institutions don't want little pieces. The individuals seemed almost tapped out this week. It was scary. It felt like capitulation. And I think we got a panic bottom on Thursday that we will revisit and may even hold. But that's a very risky bet because the owners of these stocks do not seem to be reliquefying on the rebound. If you were margined and you got Thursday and Friday morning's rally you should have been using the strength to sell. But few people were. Or else these stocks would not have gone up in a straight line.)

Of course, that triggers more margin calls as NationalGift's collateral value falls further. So, tomorrow those who were using NationalGift's stock to buy other stocks will have those sold out from underneath them.

(This is the sickening spiral we saw all week as margined player after margined player got cashed out. Somebody asked me how that could be since many of the stocks that went down weren't marginable, meaning you couldn't borrow to buy them or that you couldn't use them as collateral. But lots of what has been happening is people buying stocks for the day and then getting hammered and having to sell those stocks, marginable or not, in the last hour when they didn't hold. That makes for some very ugly closes.)

Third, the companies themselves that are being sold have no control over their float whatsoever. None of these companies has a buyback to take out some of these individual shares.

(Companies that just came public aren't about to start buying back their shares. Many of these companies are brand new, young companies grow and need cash to grow.)

Most of the companies are burning cash like Duraflame logs.

(The last thing you want to do when you want to grow your business is to go buy back your stock. People want growth, not retrenchment.)

They can't stem the decline. That is quite different from big companies, all of which are eager to buy back their stock on down days and would salivate at some of the opportunities. So the companies can't help the margined players out of their jam.

(This is a very key point. In the '80s, after the crash, we saw a lot of companies institute regular, steady buybacks that can cushion the regular imbalances that stocks have during moments of panic. Coke (KO) , for example, buys stock back every day. It has huge cash flow and it is eager to deploy that cash to buy in stock. For many companies, the more stock they buy back the less they have to pay out in dividends. But young companies don't have dividends and they don't have the luxury of throwing off cash. They can't help make the market orderly. So we get this avalanche that can't be stemmed.)

Fourth, many of these stocks were hard to borrow so they weren't shorted. So there are no natural buyers of them. There is nobody looking to cover that can cushion the fall.

(Here is an incredibly important point. Let's have a little history lesson. Until April, if you shorted a dot-com you got your head handed to you. On the way to multibillion dollar market caps you saw many short-sellers who bet in favor of a decline get taken out of the game. These giant moves scared anybody. Plus, the float, or amount of stock that trades, in these stocks, can be very very small. That means they are hard to borrow. Ones that went right up discouraged any shorting and unseasoned newer stocks are very hard to predict. They can be squeezed up in a flash, hurting anybody who stands in the way or seeks to profit from a decline. But that means the natural buyer, the person who has to buy the stock, doesn't exist. In order to book a profit on the short side you have to "cover" or buy the stock back. Because nobody is short, nobody has to buy. So there is no cushion and instead the stocks can't find any support at any level.)

Fifth, the big institutions themselves don't really know these companies, having flipped them all out to the daytraders because of the big pops they got at the IPO day.

(Here is the financial crime of this era. The underwriters have lost control of their own stocks. Dot-coms come public after an extensive roadshow where management sits down with potential buyers who say they would like to buy some stock on the deal and then get more in in the after market. But let's say you come public at $19 but you open at $63, that's a disaster. I know the press portrays it as a win, but it is a loss, a big loss, because all of those institutions who got stock at $19 aren't going to average up at $63, they are going to sell or flip the stock. (Then you have a very uncertain shareholder base and one that may be shaken out during any decline. Instead of having your stock in the hands of good solid institutions who can buy more on dips, you have it in the hands of players, many of whom are margined, who have to sell on dips. You lose all your franchise owners and have a skittish weak base. Flipping is common practice on Wall Street if a stock is up 30, 40 or 50 points at the get-go. Everybody knew this was happening, but nobody did anything about it so those companies that came public with huge gaps have now suffered horrendous declines.)

They are now starting to make their calls. But unlike daytraders, many of who are technically inclined, institutions are fundamentally driven and they meet with managements, get to know the stories, be comfortable. As the decline really just occurred (although the Net has been going down since April) this process of gearing up for new names can't kick in in time to save the margined players.

(You will now see young companies have to waste tremendous time and energy doing another road show or attending every conference or meeting trying to reinstall the institutions that blew out in the first place. This is capitalism gone mad and it infuriates me. But it is the hand this market, with its emphasis on IPOs and hot money, has dealt us.)

Sixth, and finally, most importantly, no dot-com to date has been bought by a non-dot-com.

(Disney (DIS) Infoseek does not count. In fact, Infoseek is simply a search engine plus Starwave, a company that used to be's Internet service provider, which was owned by Disney. Disney wants to use some sort of tracking stock anyway. The Diller-Lycos undefined deal would have been a bricks and mortar buy but it failed to go through.)

There is no validation of any price by any non-dot-com buyer. Until a major player buys a dot-com company, you will not have such a validation.

(Bricks and mortar companies have all wanted to create new forms of stock to be able to buy dot-coms. But any time you even discuss the notion of an old-line buying a they just laugh in your face. I still haven't met anybody at an old-line firm who believes in a with his heart and soul. Even now they are all viewed as being too expensive. The dichotomy is just too great. We won't see a real bottom until dot-coms are valued like all other companies, because, in the end, that is all they are. And as they fail to execute, or stumble, or have a decline that makes it so they are valued on earnings instead of pageviews, you won't get another bubble like the one that just burst.)

Now, the good news. At this pace, many of these stocks will trade close to their cash levels.

(I can't believe how many people emailed me and said this wasn't true. Do some homework before you email me. Take the number of shares outstanding, divide it by the proceeds ex-the burn since the deal and you will see what I mean about having a ton of cash per share.)

At that point, well-capitalized old-line players who have patiently waited can go buy these companies for their own stock and the venture capitalists and insiders will be glad to get something.

(We are nowhere near that point yet. But another leg down and we will see some acquisitions and Wall Street will regard it as opportunistic.)

Right now many, many people who work at these companies have seen paper fortunes disappear and have options that now won't come into play.

(Oh boy, is there pain among the people who came on board in the last three months. But we are still so far above where the venture capitalists got in first that these prices remain terrific. Hence the massive decline in Inktomi, (INKT) and yet everybody was still plenty happy to sell. You will see much more of that in the future.)

If you are waiting for that takeover bid, though, you are wasting your time. We aren't there yet. But we are getting there.

(I don't like to bet that something is going to get taken over to begin with. If you are in this to get taken over I think you'd better rethink your game plan.)


James J. Cramer is manager of a hedge fund and co-founder of At time of publication, his fund was long Goldman Sachs. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at