Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New by David Einhorn (tohfa e dulha read online TXT) 📕

received so much attention from me. While this doesn’t excuse Allied, it became clear to me as the crisis unfolded that Allied’s abuse of fair-value accounting was more prevalent in corporate America than I had realized. What caught my attention about Allied was that as a business development company (BDC), it had to show the value of each investment every quarter. Our larger financial institutions, including commercial banks and investment banks, don’t provide even remotely similar disclosure, so it is much harder for market participants to identify, let alone prove, abuse.

Allied’s decision to ignore accounting rules and instead attack short sellers for its self-created problems was replicated by many other larger firms during the recent meltdown. Many financial institutions were (and some likely still are) technically insolvent and simply refused to recognize that reality on their books.

They have received sympathy from regulators that wish to protect them from the consequences of following the rules. In February 2009, Federal Reserve Chairman Ben Bernanke pleaded for accounting leniency on behalf of the teetering banks when he told Congress, “Accounting authorities have a great deal of work to do to try to figure out how to deal with some of these assets, which are not traded in liquid markets.”

The rules of accounting should be set by accounting authorities, who are free to improve them as they see fit and as circumstances require. Companies should not be able to pick and choose which rules to follow, and regulators should not condone transgressors.

Instead of honestly confronting the problems, leaders of our largest financial institutions and, at their behest, public officials tried to buy time by blaming the crisis on short sellers. In a desperate attempt to prop up share prices, the Securities and Exchange Commission implemented a ban on short selling of financial stocks. This emergency action, approved outside the usual government rule-making process and unsupported by any factual finding that short selling was indeed a problem, caused a 21 percent two-day spike in the New York Stock Exchange (NYSE) Financial Index in September 2008. The SEC, charged with fighting market manipulation, instead sponsored the greatest manipulation in history. It was short-lived and ineffective, and ultimately contributed to investors losing confidence in the system. By the time the ban was lifted a month later, the NYSE Financial Index had already fallen 11 percent from its preban level—on its way to collapsing 68 percent between its September peak and the March 2009 low.

If we don’t learn the lessons from the Allied experience, we can’t fix the much larger problems in our capital markets. During the recent crisis, we have seen at great pain and expense our government gatekeepers and watchdogs fail and suffer no consequences whatsoever. Our problem with the regulations was not too many loopholes, but poor enforcement of existing laws. The recent financial reform legislation doesn’t address most of the obvious problems, including irresponsible government enforcement, the exaggerated power of credit rating agencies, the existence of derivatives that add systemic risk but provide little value to society, and the presence of too-big-to-fail institutions at sizes where they remain too big to fail. If anything, the so-called reform encourages poor behavior and will likely foster an even bigger crisis.

I remain worried that perhaps it will take an even bigger crisis to bring about more needed change. When that change does occur, it will be even easier to be an optimist.

Glossary

Audit Guide

Manual created by the American Institute of Certified Public Accountants setting forth guidelines for auditing.

Balanced price

The price of a stock that matches the demand of both buyers and sellers.

Business development company (BDC)

A company that is created to help grow small companies in the initial stages of their development. BDCs are very similar to venture capital funds. Many BDCs are a type of closed end funds. BDCs are investment companies regulated under the Securities Act of 1940.

“Buy side”

Shorthand for the “buy side of Wall Street.” Firms, such as mutual funds, pension funds, and hedge funds, that invest customer capital.

Carrying value

The value of an asset or investment as reflected on the balance sheet.

Charge-off

When a loan is taken off the books and acknowledged to be a loss. It does not relieve the debtor of his obligation and the lender can continue to try to collect. Any subsequent collection is called a recovery.

Clearing broker

A member of an exchange who is the liaison between an investor and a clearing corporation. A clearing broker helps to ensure that the trade is settled appropriately.

Closed-end fund

An investment fund that has a limited number of shares. To invest in a closed-end fund, one needs to buy an interest from an existing holder at the prevailing market price, which may be higher or lower than net asset value. They are one of three types of investment companies recognized by the Securities and Exchange Commission. The others are mutual funds and unit investment trusts.

Controlled company

A company in which a majority of the voting shares are held by another company.

David’s birthday

November 20. Remember to send gifts.

Debtor-in-possession (DIP) facility

A loan to a debtor-in-possession in bankruptcy that is normally a first lien superpriority loan.

Debt-service ratio

Ratio of net operating income to required debt payments.

Defaulted loan

A loan on which the borrower has violated the terms of the loan agreement, such as failing to make timely payments.

Delinquency rate

Percentage of loans that have failed to make timely payments.

Enterprise value

The total value of a company. It is market capitalization of its equity plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

Equity “kicker”

An offer of an ownership position in a company in a deal involving a loan.

Equity warrants

Security that entitles the holder to buy stock of a company for a specified exercise price. In many mezzanine investments, the exercise price is a nominal amount.

Exercise date

The day on which an investor can exercise an option or a right.

“Fair value” accounting

Requires assets to be carried at their fair value—the amount at which that asset could be bought or sold in a current transaction between willing parties, other than in a liquidation.

Financial covenants

Financial