In response to the financial troubles of Wall Street investment firms and insurance companies, the U.S. government banned short selling — a common investment strategy of hedge funds — on nearly 800 finance stocks in September. William Ackman, a prominent “hedge fund activist,” believes that the measure is misguided.
The “principal source of the problem” was not short selling, which “keeps prices nearer to real value”, but rating agencies like Moody’s that gave Triple-A ratings to corporations that didn’t deserve them, said Ackman, managing member of Pershing Square Capital Management, L.P.
During a Law and Entrepreneurship lecture in September, he said that the job of doing due diligence is “outsourced to for-profit rating agencies” which have little incentive to give poor ratings. By meting out high ratings, agencies ensure repeat business from corporations and higher profits. Instead of strait-jacketing hedge fund managers, the treasury secretary and the SEC chairman should consult with them on a regular basis, said Ackman.
In 2004, Ackman demonstrated how short selling MBIA, the nation’s largest bond insurer, exposed the company’s unsound financial practices. Ackman released a 66-page report arguing that the insurer didn’t deserve its triple-A ratings because it was overleveraged and didn’t have enough capital to cover losses. He took a short position — selling borrowed stock, expecting to repurchase it at a lower price — on MBIA. MBIA countered by accusing Ackman of spreading false rumors and the SEC began investigating Ackman for manipulating the market in his campaign against MBIA. Finding no wrongdoing on Ackman’s part, the SEC shifted the probe to MBIA. MBIA eventually paid $75 million in settlement costs. Four years later the market backed Ackman’s claim: MBIA lost 91% of its value by June 2008.
Along with short selling, promoting transparency and disclosure in company financials can also help correct the market, said Ackman. At the time, Ackman said that it was a good environment to do business, but the finance system was also at risk and better regulation was needed in terms of leverage. We are witnessing the “greatest bubble in the history of the credit market,” said Ackman, who predicted that more bank failures would follow.