In the House Financial Services Committee hearing Monday on Bernard Madoff’s $50 billion alleged Ponzi scheme, some good points were raised by Congress members of both parties. One was particularly relevant:
Representative Stephen F. Lynch, Democrat of Massachusetts, said short-sellers seemed to know about the Madoff fraud and the S.E.C. should have seen it coming. “The short-sellers knew it was coming and they invested in it — how did they know and the S.E.C didn’t,” Mr. Lynch asserted. “These short-sellers were able to diagnose it, bet on it and make a killing on it.”
Lynch’s point was a little unclear. Madoff’s company was not publicly traded, and thus couldn’t be shorted in the traditional sense. Lynch could have been referring to two related issues though. One is that hedge fund managers such as Harry Markopolos were apparently coming to the SEC to blow the whistle on Madoff. But their appeals fell on deaf ears
The other point is, as John Berlau has noted before on OpenMarket, that short-sellers knew the subprime crisis in general was coming and profited from that fact. Had short-selling rules been liberalized for vehicles such as mutual funds as well as hedge funds, many more retail investors could have profited as well, and the bubble may not have grown nearly as big if more shorts had balanced out the bullish longs.
Lynch should be applauded for standing up for the beleaguered shorts. And his words of praise for them hold out hope that Congress may, at last, come to realize that contrarians – those who view rapidly (apparently) appreciating assets as dangerous and invest so as to dampen such “irrational exuberances” — play a valuable and suppressed role in the market. Perhaps, that thinking may lead to reforms of laws discriminating against short sellers.