Street Capitalist: Event Driven Value Investments

On the hedge fund industry

ROSE: What’s happening, in your judgment, to this industry?

ACKMAN: The answer is it depends on what you benchmark the industry against. You know, the markets are obviously having a difficult year, and also something extraordinary happened to hedge funds. Hedge funds generally go long and they go short. And hedge funds woke up on a Friday in September. All of a sudden it was illegal to be short. That caused hedge funds to lose enormous amounts of money, as they were surprised that something that was perfectly legal for many years became illegal.

ROSE: This is so important. I’m going to have you do the definitions, even though we talk about this all the time, here on this program and other places. Tell us what a hedge fund is and going long and going short.

ACKMAN: A hedge fund is really an investment partnership. The difference between a hedge fund and a mutual fund is that the manager is compensated largely on performance. A manager typically gets 20 percent of the profits. A manager typically has a very large investment alongside his investors. I would say that’s the principle difference.

ROSE: And he gets two percent fee, two in twenty?

ACKMAN: One to two. It’s a good business.

ROSE: Yes. It’s a good business because you got it going both ends. You’re going to make your money, and if it goes up you get 20 percent of it. If it goes down –

ACKMAN: You’re out of business at a certain point. So you won’t get that two percent for long.

ROSE: Right. So it was a huge thing for how many years?

ACKMAN: The hedge fund business or short selling?

ROSE: Hedge fund.

ACKMAN: Hedge funds really started — Ben Graham, going back to Warren Buffett’s mentor, He was a hedge fund manager in effect. He went long and occasionally he went short. But it didn’t become a real industry where there are thousands of participants until five, six, seven years ago.

ROSE: And going long and going short means?

ACKMAN: Going long and going short — going long is making an investment. You buy a stock on the exchange. Going short is borrowing a stock, selling it on the hope you can buy it back on a lower price.

ROSE: You were a very good short seller.

ACKMAN: Occasionally we got it right.

ROSE: You were a very good short seller.

ACKMAN: Not always. It’s a difficult business.

ROSE: When the government shut it down for a while, it was terrible for people in the hedge fund business.

ACKMAN: It was more that the rules of the game were changed mid- stream. I think if the government had said, look, we’re going to phase out short selling over a period of time, it wouldn’t have been disastrous for an industry. But if you have investors who commit to their partners to stay balanced, they don’t want to be more than a certain amount long versus the amount that they’re short. You lose the ability to insure yourself. Short selling is really a form of protecting yourself from the market going down. By taking away that very important tool, managers got imbalanced. They were actually forced to sell their long positions.

We’re not large short sellers shorting stocks. Most of our short selling we do through derivatives, another topic. But something called a credit-default swap is a way to be short.

On the credit crisis

ROSE: What did you see and when did you see it, to paraphrase Howard Baker’s famous question of the Nixon administration people? What did the president know and when did he know it?

ACKMAN: I was princely a long investor for the first ten years of my investment career. In 2002, I came across a company called Farmer Mac, which is a GSE, not that different from Fannie and Freddie, but that operates in the agricultural credit market. It was recommended to me as a long investment, something I should buy. The more I looked, the more I concluded that this was a good short. And without going into too many details, I bought a credit default swap and it turned into a profitable bet.

I then looked at Fannie and Freddie. Actually in 2002, I made short bets through credit default swap market on Fannie and Freddie, but ultimately gave up because I thought of them as too big to fail. But as part of that research, I was looking for other companies that had Triple-A ratings, where perhaps they didn’t deserve their rating. I came across a company called MBIA, which is a bond insurer. It’s a company that started out in a very low-risk business, guaranteeing California bonds, for example. And over time what you see with financial institutions is that as markets become more competitive, they’re forced to take on more risk to make their share holders happy.

The bond insurers were started out as almost cooperatives. They weren’t for profit in a conventional sense. But in the early ’90s, most of them went public. They had demands from their share holders and management was compensated with option. They started to look for other avenues of profit. They had a Triple-A rating from the rating agencies.

So Wall Street got ahold of them, and said, look, you guarantee California bonds. You guarantee hospital bonds. Why not grantee corporate risk? Why not guarantee mortgages? Over time, they started to enter a market they knew less well. They’re very leveraged companies. What struck me when I first opened the annual report of one of these companies is they had a Triple-A company, yet over 100 to one in leverage. That just didn’t compute.

ROSE: Unbelievable, doesn’t compute. We think of 30 and 40 to one as high.

ACKMAN: Yes. But the world up until recently was a world that believed, you know, the financial markets were –

ROSE: What does that mean, the world believed.

ACKMAN: Where investors would buy a bond based on its rating. They’d buy a CDO. They’d buy a complex security. It was too difficult for them to analyze. They outsourced the analysis to three companies, the rating agencies.

On ratings agencies

ROSE: One person after another has come to this table and just cast huge criticism at the ratings agencies.

ACKMAN: Yes.

ROSE: It’s all deserved?

ACKMAN: It’s deserved.

ROSE: How did it come to that?

ACKMAN: You know, I think the rating agencies perform what amounts to almost a regulating function. Determining the credit worthiness of a bond is something that the SEC uses to determine the capital adequacy of an investment bank. So they got an almost sovereign like-status, but they were for profit entities. That for profit nature of what is a quasi- regulatory body caused them I think to push for production. And, you know, the incentives of trying to meet next quarter’s earnings can cause someone to — in a competitive marketplace perhaps to sign off on a rating that wasn’t deserved.

There was a lot of rating shopping. An investment bank would walk into Moody’s and say, look, here is a risk. We’re looking for a Triple-A rating. It would be analyzed by Moody’s and they’d say, OK, it’s Triple-A. The investment bank would say, what, if I throw this in, is it still Triple-A? They would say, looks Triple-A to us. What if I threw in a few more bad mortgages, is it still Triple A? At some point Moody’s would say, it’s no longer Triple-A. They’d say OK. Then they’d walk across the street to S&P. They’d take a look at it, and if they said yes, they’d get paid a 600,000 dollar fee. Yes, it’s Triple-A. If they said no, they wouldn’t make any money.

ROSE: That raises a big question about what’s going to happen to rating agencies.

ACKMAN: I think they’ve become a lot less relevant.

ROSE: People have to do their own credit analysis.

ACKMAN: You can’t outsource credit analysis. The problem with the rating agencies is that these monikers, the good house-keeping seal of approval of a Triple-A rating has lost its value. That was exported around the world. So it’s almost like regulators around the world deferred to the rating agencies, and that caused securities that probably should not have been sold to spread around the world. And the crisis that we’re in now is largely because people took their — if you think about the Internet bubble, when people lost a lot of money, it wasn’t as bad –

ROSE: There were no earnings.

ACKMAN: The Internet bubble, people were taking not their savings they needed to make mortgage payments, they took their highest-risk assets. They knew they were taking a risk when they were buying floose.

ROSE: They were betting on the comp, so to speak.

ACKMAN: But people who invested in Triple-A obligation, these CDOs and asset-backed securities, took their lowest risk money. It was the money that banks didn’t have to hold capital against. It was the retiree who said I want to make sure I have enough in my retirement. The result is people have lost confidence, because they took their safest, most important nest egg funds. They put it in stuff that’s supposed to be risk-free, and it turned out to be far from risk-free.

On hedge fund redemptions

ROSE: Couple things. One, how much redemption is going on with hedge funds?

ACKMAN: A lot.

ROSE: Explain what that means?

ACKMAN: Hedge funds are not — the capital isn’t permanent. It’s a little more permanent than a mutual fund. You could call up Fidelity and tomorrow you can liquidate your entire account. The hedge fund, you have to give notice. It depends on the fund. Some funds have five-year lockups. Some have two-year lockups. Some have 90-day lockups. As investors have lost — as hedge funds have lost money — this year, perhaps, you’re right. The average hedge fund might be down 20 or 25 percent. Investors are concerned. They’re looking for sources of liquidity. And they put in a redemption notice to hedge funds.

What that means is the manager has less money. He has to sell what he owns.

ROSE: In order to pay back the persons.

ACKMAN: Which puts pressure on the market, which puts pressure on funds, which causes more redemptions.

ROSE: Do you know a lot of people that are experiencing terrible margin calls.

ACKMAN: No, I actually don’t hang around with people who use a lot of leverage.

ROSE: Really?

ACKMAN: Really. There has been too much leverage in the system.

Is it time to invest?

ROSE: This is a time of opportunity for people with money, is it not?

ACKMAN: Absolutely. It’s the single best time in my career that I’ve seen to invest.

ROSE: To invest. There’s more value out there than you could ever imagine.

ACKMAN: The spread between price and value is the widest in many years, 30 or more years.

ROSE: Prices are way below value.

ACKMAN: Yes. Not every case.

ROSE: Why do I hear so many stories — I am a babe in the water — about people sitting on cash, cash, cash, cash. They’re just sitting on it. You’re saying there are tons of great investments to be made and there is a greater spread between value and price than there’s ever been. And yet they’re sitting on cash.

ACKMAN: Yes. A couple reason, one, if you don’t know how much money your investors are going to ask you for, you have to put aside money to take a conservative point of view. Very few people have permanent capital. Mr. Buffet is about the most fully invested we’ve ever see him. He spent 50 billion in the last few months. I mean, it’s hard to keep track. He can do that because his capital is permanent. Most investors in the marketplace, mutual funds, hedge funds, managed account managers –

ROSE: His capital comes from money that comes into –

ACKMAN: Every day.

ROSE: From businesses he owns.

ACKMAN: That’s right. And that’s unusual. So in a marketplace where your capital isn’t permanent, people have to be on the defensive.

On Government bailouts

ACKMAN: I’ll say the Federal Reserve and the secretary of the Treasury. I focus on the TARP. The 700 billion dollars, that authorization from Congress, I think so far has been spent well. Two hundred fifty billion dollars going into some of the best banks in the country so they’ve got more capital to lend, so that there is more confidence in your counter-parties is a very important first step. So I like that.

Second thing is the government taking steps to cause the rate at which companies borrow to decline. So the Libor rate, versus the interest rates that the Fed funds rate has — that spread has narrowed, which means that the cost of funding for businesses has come down. That’s a positive. So I think we’ve taken some positive steps.

I do have some concern about, you know, what you read about in the newspaper, in terms of other things they’re thinking about.

ROSE: Like?

ACKMAN: I’m concerned about G.M. Why am I concerned?

ROSE: G.M., the car company?

ACKMAN: There are reasons to be concerned, but this is a very important company for the country. It competes in a global marketplace. It’s been hamstrung for years because it has too much debt and it has contracts that are uneconomic.

ROSE: It’s in the health care business.

ACKMAN: That’s right. The way to solve that problem is not to lend more money to G.M. That just creates another Fannie or Freddie problem. The way to solve that problem is to use the reorganization system of the country. I don’t think –

ROSE: So reorganize G.M. for me.

ACKMAN: What should happen is they should do a prepackaged bankruptcy. The equity holders have been largely wiped out already.

ROSE: Because the stock is selling at two dollars or something?

ACKMAN: It’s a four or five dollar stock today. It’s maybe a couple billion dollar market cap. The debt trades at 30 cents on the dollar.

ROSE: You can buy all of general motors for two billion dollars.

ACKMAN: And you’re over-paying.

ROSE: You’re over-paying.

ACKMAN: You’re over-paying.

ROSE: That’s why nobody has bought it.

ACKMAN: What you need to do is reduce the amount of debt at General Motors to a level that the company can support, and the debt holders, in exchange for giving up their debt claim, will end up owning the business. What you want is a General Motors that can compete. You don’t want to lend tax payer money to an insolvent company so they can pay interest to the people who lent them money five years ago. That’s not a solution to the problem.

I’d rather the government’s money be used to retrain employees for other jobs, for infrastructure. You know, the welders at General Motors are going to be — can help on the infrastructure of the country. That’s a much better use of tax-payer money than lending money to an insolvent company. So we can’t be afraid — the bankruptcy word scares people. It’s simply a system. I have no economic interest either way in General Motors. But I guess for the good of the country I have an interest in General Motors. I’d like to see General Motors have a capital structure.

ROSE: Should it merge with Chrysler?

ACKMAN: If that would make the company more efficient, it should. It’s just like Fannie and Freddie. You have two companies that effectively perform the same function. My guess is there’s significant –

ROSE: What about Ford?

ACKMAN: If it makes sense, I think we should design –

ROSE: One great American auto company.

ACKMAN: We should design an auto company that can compete on a global scale.

ROSE: So you buy into the recapitalization program when you think the auto companies ought to be reorganized.

ACKMAN: There’s a viable business at General Motors, but it needs a different –

ROSE: It seems like what you’re basically saying is that the federal government is making a mistake.

ACKMAN: Yes.

ROSE: And Congress is making a mistake, if, in fact, they think that just pouring money into AIG or into General Motors will solve the problem.

ACKMAN: AIG is a little different from the other two, but you have to start with — once you’re done with the tax- payer putting in — if you look at the bank bailout, it was done very well because the government didn’t go invest. It put preferred stock in only solvent institutions. Right? They’re not — they’re letting — 17, 18 banks have failed. They’re letting them fail, because there is no hope of rescue.

ROSE: Should Lehman Brothers have been allowed to fail?

ACKMAN: It’s a complicated question. I would say my regret with Lehman Brothers is if you — once Bear Stearns was saved, the message on Wall Street was we’re going to let shareholders die, but we’re going to protect counter-parties. As a result, when Lehman failed and the counter- parties lost 90 cents on the dollar, more money was lost, in my opinion, than should have been lost. If the government had said, look, we saved Bear because we didn’t have time to figure it out — it was over the weekend. They had plenty of time to know that Lehman had issues and they should have let the market know, this is the last — we’re not going to save every counter-party.

ROSE: My impression is Lehman went around looking for buyers and, in fact, there was a South Korean buyer that might have been in place for a while, et cetera, et cetera.

ACKMAN: Apparently Buffett made a proposal that was rejected. I think Lehman could have been saved, but I think the management loved their institutions too much to take money on terms they thought was unfair. And ultimately it cost the institution.

ROSE: They didn’t realize that the failure to take that deal would be the consequence they found.

ACKMAN: Also, investment banks were never 30 to 40 to one levered institutions until more recently.

The future of investment banks
ROSE: Where are we with investment banks today? I’ve had one guest after another, Ace Greenberg, among others, saying investment banks, as we have known them, are gone forever.

ACKMAN: I think that’s right, as we have known them recently. I think we’re going back to the old model.

ROSE: In terms of Morgan Stanley and Goldman Sachs.

ACKMAN: I think there are some very profitable investment banks in the old model. Lazard is a very profitable investment bank.

ROSE: It’s like a boutique, though.

ACKMAN: It doesn’t take enormous — it’s not a 40 to one. People pick on hedge funds for being levered. Many Wall Street firms became hedge funds.

ROSE: What was the leverage at Goldman Sachs.

ACKMAN: High, 30 plus. When your competitor is levered 30 to one, you have to do the same.

ROSE: Paul Volker has questioned this program, the model of big investment banks that have hedge funds under the umbrella. Big investment banks should or shouldn’t have hedge funds?

ACKMAN: Actually, in my view, investment banks became hedge funds.

ROSE: That’s what some have said to me. Some have said to me that private equity firms are the new investment banks.

ACKMAN: Yes. Yes and no. I think there are some issues there, too. Too much leverage. I think that, you know, we went through a period of time where the consumer, the investment bank, the business got attracted to very low-cost money.

ROSE: There is a problem right there. It was too much easy money, in part.

ACKMAN: That’s right.

ROSE: That got to be such a distance between the person who was making the loan and the person who was asking for the loan.

ACKMAN: Exactly right.

ROSE: Credit risk got way out of whack.

ACKMAN: Correct. Fueled again by the rating agencies.

When will the housing market turn around?

ROSE: And the housing market will turn around when?

ACKMAN: OK, I’ll try to be optimistic because I’m an optimist. Come the turn of the year, we have a new president; we have much lower interest rates than we’ve had for a long period of time; housing prices have come down a lot; it’s the spring; you’ve been wanting to buy a home for years. You’ve saved money. You’ve been a good citizen. You’ve not borrowed too much on your credit cards. A house that used to cost 600,000 dollars is now available for 280,000 dollars. Fannie and Freddie are in business.

ROSE: And money is at one percent.

ACKMAN: Money is cheap.

ROSE: What is money at?

ACKMAN: The answer is it’s less so much the cost of money. There is money for a good credit consumer that puts down a 20 percent down payment. The problem –

ROSE: That’s right.

ACKMAN: It’s really in the corporate world. What’s causing the economy to weaken is that companies are not concerned they’re not going to be able refinance their debts they have coming due.

ROSE: Because banks aren’t lending money.

ACKMAN: That’s right.

ROSE: Banks don’t lend money, they can’t pay their debts. They can’t pay their debts, they can’t make their products. They can’t make their products, they can’t pay their employers. They can’t pay their employees, they’re out of business.

ACKMAN: That’s right. We need to fix that problem. We’re on our way. We’re not there yet.

ROSE: Have we turned the corner though?

ACKMAN: I think we have certainly turned the corner.

The new presidential administration

ROSE: So you’re optimistic because we’ve turned the corner?

ACKMAN: I’m optimistic we’ve turned the corner. I’m optimistic about the new administration.

ROSE: Why are you optimistic about the new administration other than it brings optimism to the country?

ACKMAN: First of all, that’s important. A lot of what’s going on is driven by mood. Confidence plays an enormous role.

ROSE: Trust and confidence?

ACKMAN: Not just the consumer level but at the business level. If an executive feels like he can grow his company, he will spend money. So I think having a leader that can inspire the people, having a leader that can stand up and say, “the only thing you have to fear is fear itself,” it reminds me of a — the U.S. is a turn around now. We invest in turn arounds. They can be difficult, but we’ve got a lot of wonderful assets here.

We have a country that people want to live in. The U.S. government is incredibly solvent. People get concerned about an extra trillion or two of debt. That’s a very big number, but you have to remember that the government owns 35 percent of every corporation because they have taxing power. The government owns 40 percent of every wealthy individual’s earning power. That’s a big off-balance sheet asset.

We’ve got a solvent government. We borrow in our own currency, and the new CEO of America is not going to be afraid to make big decisions, because he doesn’t have to live with any legacies.

via After Frantic Day, Wall St. Banks Falter (NYTimes)

Lehman Brothers Holdings Inc., once the fourth-largest U.S. investment bank, said it intends to file for bankruptcy after Barclays Plc and Bank of America Corp. abandoned talks to buy the crippled firm.

Lehman, one the biggest underwriter of mortgage-backed securities, plans to file a Chapter 11 petition in the U.S. Bankruptcy Court for the Southern District of New York, the firm in a statement today. The filing will be by the holding company and won’t include any of its subsidiaries, Lehman said.

Lehman Brothers to File for Bankruptcy After Suitors Drop Out (Bloomberg)

via Lehman Brothers Bankruptcy Press Release (PDF)

I was expecting another one of Henry Paulson’s Sunday brunch emergency deals, but it looks like the deal with Lehman Brothers (NYSE:LEH) has hit a snag:

The fate of Lehman Brothers Holdings Inc.’s darkened early Sunday afternoon with Barclays PLC, the sole remaining bidder for the 158-year-old Wall Street firm, telling federal regulators that it is walking away from a transaction, people familiar with the matter say.

The situation was rapidly evolving, and it’s possible Barclays or another bidder would emerge to save Lehman before markets opened Monday. But with the government balking at putting any taxpayer money at risk for Lehman, the likelihood of a transaction was dimming. That would leave an orderly liquidation as the most likely scenario, a dramatic outcome for a once-powerful firm…

The main stumbling block for any Barclays deal is a reluctance by U.S. regulators to financially back an acquisition or the creation of a so-called “bad bank” to wind down Lehman’s assets.

Barclays Walks from Lehman Deal; Likelihood for Transaction Narrows (WSJ)

As of this weekend, there were only two serious bidders for Lehman Brothers. Barclays (NYSE:BCS) and Bank of America (NYSE:BOA). Bank of America also chose to walk because there would be no federal financing involved.

The lack of a deal makes the risks high for everyone on Wall Street. Earlier this week on Charlie Rose, Robert Rubin (of Citigroup and Goldman Sachs fame) described the situation best:

RUBIN: Well, three things I don’t know. One of them is what the circumstances are and whether they really are in that serious a situation. Number two, whether they are so interconnected — you say too big to fail, I think the standard now has become too interconnected, or the issue has become too interconnected to fail. That`s after all the problem in Bear Stearns. My instinct is if that Bear Stearns was too interconnected to fail, the probability is that Lehman is.

If that’s the case, then the policy makers have to make this very complicated judgment of whether to intervene or not intervene, and the argument against intervening always is that in a market-based economy, failures should be rewarded with failure and success with reward. But on the other hand, the systemic risks of allowing these interconnected institutions to fail are such that I think as you weigh and balance all this, there are times when government is going to have to intervene. Then the practicalities of how do you do it can become very complicated.

Lehman Brothers does indeed pose a systemic risk for the rest of Wall Street.

A disorderly unwind of Lehman’s derivatives trades is only one worry. Another worry is that if Lehman collapses, its distressed assets — such as commercial real estate — could suddenly hit Wall Street for sale, forcing prices even lower and potentially forcing other dealers to mark down once again the value of their own holdings.

The possible merger between Bank of America and Merrill Lynch (NYSE:MER) seems to stem from the fact that anyone who held similar assets will be in a world of pain tomorrow as banks may have to further mark down toxic assets if Lehman liquidates. It’s a fact that Merrill holds more of these types of assets than even Lehman, so they may be forced into a shotgun marriage because capital raising will be difficult. EDIT: WSJ is reporting a deal at $26 per share for BoA-Merrill Lynch

In order to dampen any kind of blow that a liquidation might have with derivatives, the International Swaps and Derivatives Association announced that they’ll arrange to net any transactions involving Lehman Brothers. In a statement released today they say:

ISDA confirms a netting trading session will take place between 2 pm and 4 pm New York time for OTC derivatives. Product classes involved are credit, equity, rates, FX and commodity derivatives. The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy filing. Trades are contingent on a bankruptcy filing at or before 11:59 pm New York time, Sunday, September 14, 2008. If there is no filing, the trades cease to exist. These trades are subject to a protocol which is being distributed by ISDA (International Swaps and Derivatives Association). Traders should execute the protocol and return to ISDA

ISDA Statement on Lehman Brothers Bankruptcy Trades: Full Text (Bloomberg)

Netting would be the right course of action to take. Doing so would not only lower systemic risk on Wall Street, but also the capital requirements needed by banks to service such contracts. To give you an idea of how it works, look at the image posted below.

Netting would help reduce some of the risk stemming from Lehman liquidation. The amount of capital needed would be based upon the economic position that results from the outcome of each contract, rather than the amounts stated in the actual contracts. This means less capital will be needed on both ends of the deal, which should be helpful if Lehman goes bankrupt. The ISDA’s actions will probably help, but not enough to create a good day for stocks tomorrow. It might be a good time to monitor your watch lists for any high quality companies that you’ve been hoping will be on sale.

Found this chart via Bloomberg:

Looks like traders are betting that Lehman Brothers (NYSE:LEH) is in bad shape, but not nearly as bad as Bear Stearns so far.

Another casualty of the credit crisis was announced today, Erin Callan the CFO of Lehman Brothers (LEH). I find this interesting because Callan has only held the job since December. Callan was even the feature of some favorable stories in the Wall Street Journal:

After sifting through the numbers for nearly an hour, Ms. Callan coolly answered more than 20 analyst questions. Then she strode down to Lehman’s bond-trading desk and high-fived trading executive Peter Hornick. Later that day, bond traders gave her a standing ovation, a Wall Street rite typically reserved for CEOs. Profit had plunged, yet Lehman shares surged 46%.

Six months into one of investment banking’s toughest jobs, the 42-year-old Ms. Callan is emerging as a galvanizing force at Lehman and a finance chief who topples much of the conventional wisdom about CFOs. She also is the highest-ranking woman on Wall Street. Many Lehman insiders consider her among the contenders to become the firm’s president someday.

Unlike Lehman’s two previous CFOs, Ms. Callan isn’t an accountant and had never worked in the finance department.

Lehman’s Straight Shooter (WSJ)

These changes weren’t enough when Callan famously came up against famed value investor David Einhorn of Greenlight Capital as he launched a short campaign against the company. David Einhorn is one of the best value investors today, he definitely is able to apply traditional value investing to areas that most investors skip over like pharmaceuticals, technology, and financancials. He should be studied by any aspiring investors.

The difficulty that Callan faced was having to defend Lehman Brothers against Einhorn’s insurgency in a time when the company already faced extreme pessimism. In an environment like this, a company like Lehman is weak. The large amounts of leverage they employ hold them hostage if there’s a crisis of confidence. Lehman had winded down some of their leverage, going from the low 31.7:1 to 25:1, but still – this is still excessive. Einhorn’s claims were easy to rock confidence in Lehman because he questioned their accounting, the foundations of their financial position – in doing so he (or the market) forced Lehman to pursue $6 billion in capital.

To see how Callan sought to pacify Einhorn, just look here:

In his comments, Mr. Einhorn squared off in particular against Erin Callan, Lehman’s chief financial officer and the executive who has led the public charge against the firm’s critics. Mr. Einhorn met with Ms. Callan last week to discuss his research.

In a statement, a Lehman spokeswoman said: “We will not continue to refute Mr. Einhorn’s allegations and accusations. Mr. Einhorn cherry-picks certain specific items from our quarterly filing and takes them out of context and distorts them to relay a false impression of the firm’s financial condition which suits him because of his short position in our stock. He also makes allegations that have no basis in fact with the same hope of achieving personal gain.”

In attacking Lehman, Mr. Einhorn took issue with large, unrealized gains the firm booked in the first quarter from marking up equity positions that don’t trade in public markets. Like other brokers, Lehman has large amounts of illiquid assets that it values using management-driven financial models.

A Shorter Slams Lehman (WSJ)

By choosing to ignore or “not continue to refute” Einhorn’s claims, Lehman makes it easy to appear sketchy to any of the company’s outsiders. I’m not expert on the company, but when someone like David Einhorn goes around giving presentations that easy describe and show how weak your company is to hedge funds and the general public – the precise people who can hurt your company, you should not decide to “not continue to refute”.

In refuting, a company legitimizes the short-seller but they also have a chance of countering whatever may be flawed in the analysis. Not refuting almost makes it look like Lehman has something to hide. From my experiences, I’ve noticed that most companies try to brush aside short-sellers, as if de-legitimizing them is good enough. Often it isn’t. Often, companies need to engage in an aggressive operation where they actively come up with easy-to-consume evidence that counter’s the short’s claim. I’m talking 100 slide power points a la Bill Ackman. This could be a problem if your company really is sketchy and in that case then the short will triumph. Also, Lehman could have tried to push its efforts towards discrediting Einhorn. No investor is infallible, just look at Einhorn’s investment and directorship of New Century Financial (he did note that Greenlight’s analysis was “sub-prime” for New Century). This would have been better than simply ignoring him and hoping he goes way. If a company can bring evidence that its position is sound, then it should do everything in its power to show that, at the very least it can bolster or even increase their stock price.

Lehman’s precipitous fall in stock price demonstrates that they did not do enough to assuage investor fears and with any luck, under the new CFO Ian Lowitt, Lehman will be able to handle these issues with better execution. Management of companies who are currently engaged with short sellers could do themselves a favor by reading up on counterinsurgency (COIN). COIN after all is in its essence is “winning hearts and minds of the people”. Winning the hearts and minds of the investor community would do good for any company’s stock price.