Limit Company Size and Encourage Short Selling

Dylan Ratigan has established himself as a top financial anchor and reporter through his work on CNBC shows such as "On the Money" and "Closing Bell" as well as during his tenure at Bloomberg News, where he served as a Global Managing Editor and host of its "Morning Call" program. He is the anchor and co-creator of CNBC's "Fast Money"and the co-anchor of "The Call" and the 3 p.m. hour of the "Closing Bell."

By Dylan Ratigan

Warren Buffett recently urged us all to follow his lead in buying American stocks during this fear-driven down market, invoking his common sense wisdom of being greedy when others are fearful and being fearful when others are greedy.

While I appreciate and agree with Buffett that it may be a good time to invest in this great country's long-term future, I also think there is a lot the Warren Buffetts of the world can do right now to help ensure a prosperous future.

First, we need to take a realistic view of how we got into the current financial calamity.

Instead of creating a society that harnesses the powerful force of capitalism to benefit us all, which resulted in the development of light bulbs, automobiles and computers, we have created a system in which the spirit of innovation has been hijacked to find better ways to cheat society for personal gain.

We have to face the reality that regulators alone can never keep ahead of the cheaters. An unfortunate aspect of human nature is that some people will always try (and succeed) at "gaming" the system, no matter how prescient and attentive our regulators.

I believe the solution to the current and historical problems with capitalism is to enact two pieces of regulation.

First, we must never again allow any company to become "too big to fail." Companies, by their very nature, take risk. Because of the competitive nature of capitalism, there is no amount of regulation, transparency or prudence that can successfully prevent companies from occasionally failing. This is especially true of banks, which will always be tempted to increase profits by pushing the risk envelope and will always find ways to do so.

Just as traditional commercial bank regulators have the authority to curb an excessively risky bank, we need to enforce a limit on the size of non-bank financial entities. This measure could help stop the inevitable failures that cause the systemic failures for which we are all now paying.

Second, and the most pertinent to Mr. Buffett, is that we need to promote, not stamp out, short-selling. It is only through the use of the skeptical force of short selling that those who would seek to inflate their company’s value by hiding or manipulating information will be forced to provide transparency that regulations could never mandate.

The wonderful thing about a stronger system of upward and downward pressure is that it forces companies to be more accountable. And if there is anything lacking these days, it is accountability among managements.

So instead of an activist like Carl Icahn trying to take over the board of a company, he could simply raise a "short" fund to target companies that have loaded their boards with cronies and yes-men.

Or the next time Warren Buffett labels something like derivatives as "financial weapons of mass destruction," he could instead tell us which companies to bet against. This will force these companies to change their behavior more than any government regulation ever can.

There is a reason why CEOs who helped get us into this mess regularly blame short sellers for their failures.

It is because short selling forces CEOs to either disclose what they are doing or suffer consequences for their secrecy. But rather than admit to 40-1 leverage, they loudly stigmatize those who would dare to bet against their companies.

Unfortunately, merely choosing "not to buy a stock" is not enough to force this kind of necessary transparency, for there is always a "greater fool" down the road to buy it. We need to actively punish these companies and managers in our role as profit-minded investors.

In simplest terms, choosing not to buy a stock because you don't like the company is like refusing to be friends with a drunk. But shorting a stock is like sending a drunk into rehab. Many of these companies, drunk with money and neglectful of risk, should have been sent to rehab a long time ago.

Obviously, we can never again allow the system to become so vulnerable to inevitable future corporate failures. But just as obviously, we can also no longer trust government alone to catch the cheaters and liars that have bastardized American capitalism.

Let's apply the human nature that creates these problems to expose and punish them financially. We must no longer pay heed to disgraced CEOs who falsely claim that their downfall was caused by "those evil short sellers."

Let’s face it - sober people do not mistakenly end up in rehab because it is so easy to prove that they are sober. But when we discover they are regularly drunk at lunch, that's where we can send them.

I can think of no one better than Warren Buffett to be that kind of friend to both our country's companies and its citizens.

Comments

[Brian]

I strongly agree with Dylan here, who by the way in my opinion has been the best financial reporter on the street while this has been unfolding the last year by going on Oprah, CNN, CNBC, etc. and really spelling this problem out in layman terms. What I Basically see by Ratigan's plan here is that we have the private sector working as the regulators which is far and away the best solution to this problem rather than expanding the failed SEC or building a new agency.

Dylan is one of a very, very few journalists that actually are knowledgeable in today's media. This just further proved it to me.

[Glen F.]

Well said, Dylan. Two points of yours stood out for me. The first was your comment "We have to face the reality that regulators alone can never keep ahead of the cheaters." That statement says much more than what most people realize, you know that, right? Because I'm sure you, as a journalist, like details with your reporting, correct?? So next time you bring up those facts on television, imo, you should bring up there are only two ways to describe our government when discussing the current financial crisis...or most items. Either, like you say, our government is not smart enough to stay ahead of the cheaters (the public), or, in this case which I do believe, the cheaters are also within our government itself. Neither is a good answer, but there really isn't any other answer to apply here.

The second comment that caught my attention was "So instead of an activist like Carl Icahn trying to take over the board of a company, he could simply raise a "short" fund to target companies that have loaded their boards with cronies and yes-men." Dylan, I posted about doing this a month or so ago on this blog. If I was Mr. Icahn, I would be talking more to you about how you can help do the "reporting" as a media outlet spokesperson, that is, if allowed by CNBC and not jeopardizing your position. But, personally, I think you could help capture a large audience because I think you are rather fair in how you do your reporting style, un-bias, which is sometimes a rarity to see.

But, again, without a doubt I think Mr. Icahn should pursue the United Shareholders of America plan using a "fund", which, if large enough, will receive the much needed public awareness, hopefully to bring upon change to both corporate cultures as well any needed regulation, and why not make money on pushing these companies to make the necessary changes??? It only makes sense to do it this way.

And, yes, Mr. Icahn has written about the "poison pills" in place by many companies, however, I believe with enough funds behind this "fund" you also describe, I still say public awareness will be enough to squash any opponents to this way of doing business.

Dylan, I certainly hope you will continue to post on this blog, I think you are an outstanding journalist and I hope CNBC pays you what you deserve.

Glen F.

Btw, Mr. Icahn, if you take the time to your blogs, now you can see you have another supporter for the "fund" concept, not to mention the several others who posted that liked the idea as well.

Plus, you make money for a reason, correct? Well, in this case, use the "system" like these CEOs and others are, play with them at their own game. Match. Set. Game!

Lastly, I would be happy to join your team in coming up with the ideas to make it work. I may not be somebody to most, but the one thing I thrive on, and that's being an underdog.

Best wishes to you.

[Trent]

Great article Dylan. The more I research our forefathers vision/foundation for our great nation, the more I have a greater respect for their dedication to service. Tomorrow we will celebrate how great the CEO for Citi was laying off enough people to fill the Cotton Bowl. How many times will we sacrifice employees for short term artificial gains or bad business?

Who will be the gate keeper of individual shareholder value, 401K, sustainability and appropriate board room representation? The market won't get any better until the fat cats/government realizes that the foundation of our economy is the common citizens/investors. Trust/integrity has been betrayed, lost, destroyed and common shareholders have been robbed long enough, they don't trust the boards, CEOs, preffered stock offerings, bailouts, TARPS=CITI, etc.

Promote the standard of living of your fellow Americans and we will experience investors returning to this market! Why should we invest in this market or my parents when we're not being represented as a shareholders let alone fellow Americans. Often times during numerous business practices, strategies, techniques including bankruptcies the common stock is dissolved and guess who's left holding the bag? (You buy stock, you take the risks..OK) Those business games relate to lost income, capital, futures; what do we think that has an impact on..continued housing loss, individual credit dissolved, individual buying power discretion, manufacturing loss, jobs and oh yea...Lack of Trust and Confidence.

We have declared war on fellow Americans for far too long for the benefit of a few and now we're paying the price. This economy won't improve until we stop trying to wallpaper the underlying problem; citizens scared, hurting, misused and don't trust the leadership of our government, company leaders, fancy talking lawyers, robber barons, biased analysts or insensitive bankers.

I have never seen in my time of investing such mistrust or a lack of integrity and much more disturbing; absent leadership/individuals willing to stand up and protect the fellow citizens. What Manner of Men?

When we have a government/market of the people, by the people, for the people then we'll bring our capital back to the mutual funds, stocks, companies, IRAs, etc.

Mr. Icahn is doing a great thing giving voiceless people a voice to cry out their fears, capital losses and torn family structures. The majority of Americans will not return to this market until we get equal protection from the boogey man! I think the drunk can keep drinking because the new educated individual investors will cure his hangover very soon.

PS: Dylan your fellow Americans are hurting, we need your voice to convey our pain to the masses.

God Bless America!!!

[Mike Robbins]

Dylan,

As usual, I find your commentary to reflect a refreshing "no spin" take on the causes and remedies for our current economic collapse. While I've been extremely disappointed by the complete abondonment of free market capitalism by most of your CNBC colleagues, I do applaud the efforts of yourself, Mark Haines, and Rick Santelli (along with most of your "fast money" colleagues) for taking a stand on the need for accountability and transparency. Until we see some kind of return of accountability and transparency (in the markets as well as in our government), I suspect that many traders and investors will remain on the sidelines as I have.

I agree that NO business, or industry, should be deemed to be "too big to fail". When we reward corporate incompetence, ineptness, and greed by providing taxpayer-funded safety nets, we do nothing but ENCOURAGE future malfeasance and risk-taking. Thanks to our illustrious leaders on Captol Hill, we have begun a precipitous slide toward socialism that will be very difficult, if even possible, to return from. If AIG was determined to be too big to fail, surely GM and Ford will be given equal consideration. The major airlines will be next in their quest for taxpayer assistance, and the list will go on and on from there.

Only by returning to free market capitalism will America secure it's economic security and the prominence within the global economy that she has enjoyed throughout the past 50 years.

Keep up the good work!

Mike Robbins

[Chris M]

I have been greatly disturbed by this trend of "to big to fail" labels that are being applied to businesses. We appear to be making this designation the goal to reach. As troubled by this as I am, I am equally troubled by the prospect of limiting companies.

It would seem to me one of big reasons to invest in a company is the potential for continued growth. How would a company's value be affected once they hit the magical threshold where the government now says "you can not grow anymore because you will become too big to fail?" How can this work in reality and not create artificial barriers to company growth?

[Jim Reynolds]

What about short sales made by specialists?

Those sales dont do anything but help deprive intelligent would be investors of their money, by skewing rational data and instead forcing people into a "cattle like" mentality on the stock exchange floor.

[Mike B]

AMEN, Dylan!!!!!!!!

[ed]

Dylan's simplistic solution to use short selling to force transparency is just not realistic. Company's are down 90% and destroyed in weeks, before any needed changes can be wrought, and after the short sellers are finished corporate America will be a smoldering wreck, with no remaining value for the short sellers to attack

[Robert]

Dylan, As an avid viewer of your daily 5pm show, I think you have a point, however, the devil is always in the details. Too big to fail is a judgement call, and the reality is companies generally become giant through financed acquisitions. Classic wisdom supported even cheered growth through these means. Seems implausible to stop companies from growing to some magical number in a capitalist system. As for short selling, it has existed well since the 30's with some specific rules that were in place to stop abuses. Those controls were removed in June 2007 by our very own Chris Cox SEC chairman. Damn fool thing to do. Uptick rule was removed as was the enforcement of the actually locating the stock before shorting. This allowed wolf packs of hedgefunds and others to gang up on companies and sell virtually more shares that could be purchased. The stock had no where to go but down. You could almost feel the guns being trained on these companies when blood hit the street. Even the venerable Goldman Sachs felt the considerable weight of this. The bottom line is markets need strong rules to govern the market players. Or all we have is a street fight. The rules being abandoned really contributed in a large way to the destruction of many ridiculously exposed firms. With the rules in tact, the too big to fail credo would have significantly less bite I think.

[FMC]

I think this is fantastic and will work. Do we or is there a way to guard against short selling when its used to hold a company hostage or as a way to pressure for an ousting of a CEO or policy changes. Could more transparency and a revamped, stronger analyst system help?

[Mark Lee]

You want to prevent companies from becoming "too big to fail" by introducing "regulation"? Perhaps this will surprise you and other readers, but the reason why ANY company ever becomes "too big to fail" is BECAUSE of government regulation and/or protection/support that protects them from competition and or confers to them some kind of monopoly status.

In a real free market economy (which we don't have) no company could ever become "too big to fail" inasmuch as competitive market forces constantly brings in new competitors and the law of diminishing returns puts the brakes on their growth and size. In a free market economy without regulation and quasi-monopoly protection, no company could ever become too big to fail. But failures will happen. And it may be painful -- but none will prove to be a systemic risk to the system as the AIGs, Citis, Wamus, and Goldmans of today are. But it is when the people and the politicians believe that the pain is too much and then introduce "protection" for thse ailing companies that they then grow in future to become too big to fail. This is what happened to banks, insurance companies, railroads, the auto companies, etc in the past. They've all been regulated and coddled so much that they've all become too big to fail! Hence, regulation is the problem, not the answer.

You mentioned many times that companies were levered 40-1; or that they promised to insure against risk with money they didn't have. The travesty is not the leverage or the lie. The travesty is that their failure would cause anything but a hiccup to an economy. In capitalism, people lie. People fail. People make mistakes. But it is only with government dirigisme you get a situation where someone's mistake turns into a systemic risk! Moreover, government regulation erodes counterparty surveillance. Those who lent to companies levered 40-1 -- why did they do that? Those who paid premiums to insurance companies who didn't have the capital to back up their promise -- why did they do that? It's a failure of counterparty surveillance -- due to government regulation! Government gets in the middle, promises to regulated and police; and then fail to do so.

Get rid of government regulation in these areas and 1) No company will ever become too big to fail, 2) Free market players will always be on the alert for liars and cheaters and counterparty surveillance will usually ensure that cheaters and liars get caught and/or dissuade them from cheating/lying in the first place.

[Mark Lee]

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[Bill of Mt. Vernon]

Short selling is not the answer. Investing is not a Las Vegas game. If you do not own the stock in a company or do not use its products or services what that company does or does not do is none of your business. If I buy a house in a bad part of town for too much money, that was a bad decision and it will cost me but you cannot sell the house for me. The idea of selling short is morally wrong. You are adding artificial shares to the market place by selling shares that were not for sale. This is phony. If you own a company's shares you will be willing to talk to management about your concerns and encourage management to improve the company in which you are invested. Short sellers are working for the destruction of the company. This is just plain wrong. We need to be doing what is right and not attempting to make money at any and everyone's expense. Short selling is the main reason that government should not use the stock market as a place for people's retirement funds.

[C.J. Mendes]

With all do respect I believe Dylan is only partially correct here. Good common sense regulation is at the root of Capitalism. For example, what would happen if NBA games were played without referres. You would have a messy game with a lot of interruptions and heated discussions. On the other hand what type of game would you have if there were 5 referees on the court all at once? Much the same, a lot of interruptions and a lot of heated discussions...

The key to restoring our place as the safe haven to the world's investment capital is to have just the right amount of common sense regulation of our financial markets. I see this as crucial to any long term recovery.

Obviously, part of the risk in ANY free capital market is the inate ability of some individuals to bend the rules to their advantage no matter how much regulation is inacted. That will never change and is part of human nature. What we can do is enact strict and enforceable penalties to those who break the rules of the game!. Is short selling a problem? absolutely not! The problem lies in the current system of oversight and regulation that allows a Fannie Mae and a Freddie Mac to reach such levels of leverage and overall mismanagement.

In my estimation, the biggest problem our markets face in the recent turmoil is the loss of investor confidence in the transparency of our financial system. Retiring Baby Boomers for example, who had been told to invest in equities through their retirement in order to bolster growth in their portfolios to account for potentially living another 35 to 40 years in retirement have all but given up on the markets. The foreign family who sacrifices in order to invest their retirement funds here in the U.S., not because of spectacular returns but because the U.S. represents fairness and fair play in markets... You can bet those dollars will not find their way to our stock markets any time soon but will sit in FDIC insured bank checking accounts earning next to nothing in interest...

It's time for common sense...please!

[Charlie]

Dylan,

Excellent article. However, when advocating for the usefulness of short selling, I hope you will remember to advocate for a resumption of the uptick rule.

And please, please, please do not falter in your outspoken criticism of the lack of transparency in government, financial institutions, corporate governance, etc. While others nod their heads in agreement, you are the sole voice advocating for more transparency.

[Chris Z]

In response to Dylan's post

The idea of google for government is a phenomenal concept. I think you should be advocating this, to all kinds
of institutions that have insane budgets, from military to healthcare. Absolutely Brilliant.

Encouraging short selling thought? The only thing that comes to mind, is someone placing a paper bag of used dog food
on your doorstep & lighting it on fire & ringing your doorbell.

Companies have to deal with developing new, better products, keeping & getting new customers, environmental concerns,
staying competitive, obtaining and retaining great talent and people, controlling costs, etc.... constant business concerns.
Good companies are on message and pushing for all this constantly. All this takes time. Not the kinda split second buy it & then sell it.

Short selling has become an entire industry, conceptually like piranhas. Yes it can be used as a weapon ! but by working to put out the small fire, you end up getting your shoes dirty.

Buffett, buys companies. That is the man's thinking. The guy sends letters to his managers once a year. So simple it is genius. I truly feel bad for the manager
that may receive 2 letters in a year. Pumping up and pushing down stock prices ends up creating an artificial force against companies. Simply because you can move
big money against a company does not make it a "investment tool".

[Ravi]

hi ,
Why are the Big oil companies not coming to rescue the BIG 3 .
I think if i am a oil company the Auto industry is my biggest client and i would not let anyone of them fail.
So I think the Big 3 should go to EXXON, Shell
and ask for help rather than going to Senate

[BankAround]

I agree with Dylan in that short selling is a necessary part of market activity. It's definitely a way to *try* to keep the executives in check and bring some sort of transparency.

Bring back the uptick rule so that the shorts can't just pick and attack companies and create market chaos.

[Mark Lee]

Short-selling can occur because an owner of a stock agrees with a non-owner to temporarily lend his stock to him for a fee. The non-owner borrows the stock and agrees to return the stock in future, regardless of what the market price might be. This agreement is based on the right of parties to contract freely. Any hindrance to this transaction is a violation of personal liberties, property rights -- and hence the core of capitalism itself. No uptick rule should be required, not least by the government, inasmuch as any owner of a stock can sell at any time.

[Mark Lee]

C.J. Mendes,

The foundation of capitalism is NOT regulation. Regulation is the antithesis to free markets. Capitalism is founded on property rights and the right of free-exchange. The primary role of government, including protecting human life and human rights, is to protect property rights and to enforce contracts.

The analogy between a NBA game and capitalism itself is an erroneous comparison. Games are make-believe. They are artificial contstructs. Hence the need for referees to make sure the particular game is being played and not something else. In contrast, capitalism is REAL. Free-exchange is REAL. The pursuit of profit is REAL. Nothing in capitalism is a made-up construct that "referees" need to protect. The job of referees (govt) is only: property rights, enforcement of contracts, adjudication of contracts, and the protection of human life/rights. When you introduce referees to enforce "regulation" you end up with "too big to fail", erosion of counterparty surveillance, quasi-monopolies, and quasi-government entities galore!

[Peter]

I think we are doomed if we are going to rely on government to regulate correctly. Let's not forget OFHEO. Their sole job was to watch two companies and they didn't have a clue that the only two companies they were watching were in fact insolvent.

I'm surprised no one has yet mentioned the Fed. They were the enablers of this fiasco. If we had taken our medicine at the end of the tech bubble we'd be already well on our way to recovery. Instead, we inflated a debt bubble, commodity bubble, hedge fund bubble, equity bubble, and emerging market bubble right into the abyss of a housing bubble. Well done, a spectacular failure. I think Bill Fleckensteins idea of a variable interest rate is the correct path to go but I don't see anyone in government stepping up with the cahones to address the elephant in the room, the fed's responsibility.

[Daniel L.]

Dear Dylan,
I greatly admire you for your willingness to speak out and I agree with your comments in an idealistic way, but they do not reflect reality.
Several years ago, during the merger mania, American corporations claimed that they needed to merge in order to compete with foreign competitors. So, unless bigger is better is banned internationaly, there is no stopping it.
Secondly, there is no stopping the improper influence corporations have on Congress and the Executive branch. Citigroup had the Glass Steagal Act repealed so they could merge with Travelers.
Currently the Bush Administration is frantically approving as many gas, coal and oil drilling leases on Federal land while denying all solar power leases.
As Jim Cramer keeps saying "Government is by and for the corporation."

[Jenny]

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[NecessarybutnotSufficient]

The merits of this or that regulation are debatable. If you feel the necessity to write down a rule, go ahead, but it matters not to those who have no sense of direction.

I suggest you look deeper. Look at the "cheaters" and the despot management of companies that game the system. Where did they learn this form of management?

I don't think it is a coincidence that this form of management, favors personal gain over fiduciary responsibility. Look back at the surveys of 10 to 15 years ago of the MBA graduating classes in which, when asked would they engage in business activities that favor personal gain over the longevity of the company, the overwhelming response was personal gain.

This is the clear failure of academia.

How can we expect leaders to choose right over wrong when we have so clearly failed to define these concepts. The foundations of this problem were laid long ago in academia, they have not had the courage to be standard bearers, but instead have been willing participants in a system of self delusion and grandeur.

[Chris]

Hi Dylan,

I appreciate your passion for this issue both when discussing on air and in this forum. I believe your opinions are spot on.

To those that have had real (not paper) losses during this time, who do you really have to blame? I'm just throwing a reality check in there for everyone.

More to the point, for those who lost money in Lehman, for example, who do you really have to blame? Is it really the short-sellers, is it your fund manager, your financial adviser, or even Fuld? The answer is, it's your fault. You ultimately decide who and what you invest in. For those that invested in the companies that have suffered the most, what type of value principles were you using when you invested? For those that decide to leave the responsibility of managing their money in the hands of others, do you really have a leg to stand on when those "experts" lose you money? No, you don't.

Folks, books such as "Intelligent Investor", "Buffettology", the "New Buffettology", and "One Up On Wall Street" have been around for years. The principles in those books are sound, they keep you from making stupid mistakes, and they have stood the test of time. Yet, nobody cares to study them. Most, either through laziness or ignorance, don't want to manage their own money. Or, they invest in companies such as Lehman through pure speculation.

Does it really seem that hard to understand that the risk that many of these companies were taking was a bit much? Were any of their investors really reading the balance sheets and listening to the conference calls? I would say that most were not and now that they lost money that want to blame everyone but themselves.

I also have my share of "paper" losses, but I have full confidence that the "consumer monopolies" I'm invested in will make it through this storm and my net worth in the end will be just fine. While I feel for those close to retirement that have suffered real losses, I must say that a great majority of Americans brought it on themselves. Dare I bring up Enron employees who lost everything because all they ever invested in was Enron stock. You have to think people, you have to think.