This is perhaps the most foolish intervention into the market that I've ever seen our government perform.
(long post, but an interesting story . . . I think)
I'm not a huge fan of government intervention and I sympathize with the argument that functioning markets need to have short sellers . . . but our markets weren't functioning. It's difficult (impossible?) to prove, but it did look like companies were being systematically targeted for extinction. A good case study would be Constellation Energy (mostly out of the major headlines except for the fact that they recently agreed to be acquired by Berkshire). This is Constellation's (CEG) story of the past week . . .
CEG is a hybrid electric utility, power producer, commodity trading firm. About 2/3 of the company is comprised of "hard assets" (power plants, an electric distribution company, etc.) with the balance engaged in commodity trading and risk management. Approximately one month ago CEG announced that it had botched a previous disclosure about the amount of collateral it would have to post to its trading counterparties in the event it lost its investment grade ratings. As it turned out, existing liquidity sources would be insufficient to cover a three-notch downgrade to junk. At the time, CEG was in absolutely no danger of losing its investment grade ratings. All of its businesses were doing fine. There was no speculation that the trading business had suffered losses, was sitting on bad trades, or had any exposure whatsoever to housing. Two of the three rating agencies did lower their credit ratings one notch (still 2 levels above junk) and said the outlook was stable. Moody's put the company on review for downgrade and told people privately that they didn't expect to lower the rating more than 2 notches, keeping them investment grade.
CEG responded by getting commitments for an extra $2B in bank lines and announcing intentions to sell some assets. Problem solved?
Nope . . . On Monday Sept 15th the stock was down heavily on rumors that CEG had significant exposure to Lehman’s bankruptcy. CEG released an 8-K Monday night disclosing that it didn't. On Tuesday the stock and CDS were being sold heavily again, despite the company's assurances that it wasn't exposed to LEH. Later that afternoon (9/16) another false rumor spread that UBS was pulling CEG's $2B bank loan commitment. The stock dropped from ~$35 to $16 in 30 minutes and was down as much as 70% on the day before recovering half of that.
Weds morning the company released another 8-K saying that it still had the $2B bank commitment and that it was re-affirming earnings for the 3rd quarter and full year. But the damage was done . . . Standard and Poor's issued a press release later in the day saying that they were considering multiple notch rating downgrades (from a stable outlook issued just a month before). S&P cited, among other things, the impact that equity and CDS market selling had on investor confidence and access to capital for the company.
The S&P announcement was a death sentence for the firm. A multiple notch downgrade would have been a "Material Adverse Change" under the $2B bank commitment, without which CEG would have been unable to meet the collateral calls caused by the downgrade.
In my view, short sellers deliberately targeted CEG and spread false rumors with the hope of scaring the rating agencies into downgrading an otherwise healthy company and forcing its collapse . . . mission accomplished!
(A good opportunity for BRK, btw)
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