Where Is The Next Big Short?

Steve Eisman was in the news again.   People asked him where the next big short is.  I remember when I had to explain to people what shorting the market was-now thanks to Michael Lewis it’s part of the lexicon.  The short answer is he doesn’t know where the next big short is.

Eisman recently spoke at a conference and he offered up some opinions.  He doesn’t like European banking.  But, to anyone who follows finance, that is not a surprise.  He doesn’t like the Silicon Valley model of lending and says it’s “clueless” too.  But, shorting Lending Club ($LC) stock isn’t going to make you rich.  It might make you some money.

True Big Shorts come in places where no one expects them.  They are contrarian.  For the person holding the short, it’s often painful financially, physically, psychologically and emotionally to hold the position long enough for it to pan out.  In 2008, the shorting opportunity was so widespread that it became huge.  If you tried to get short in 2008, you were late.  You couldn’t have gotten the trade on.  But one thing about shorts, they don’t persist for a long time.  The 2008 short lasted from August 2008-March 2009.  Get short after that and you shit your shorts.

I haven’t thought a lot about it but I could see a few places to make money shorting markets.

However, the shorts I see are awfully tough to figure out.  It’s not readily apparent how to initiate and sustain a position to take advantage.  For example, interest rates have been at 0% for the last 8 years.  No doubt, that policy has put in excesses in many places within our economy.  One place I know that it has is in the bond portfolios of municipal treasuries.  For example, in Chicago our treasurer recently claimed a $45M dollar savings by rejiggering the portfolio of bonds they hold.  How did they do it?  They increased the duration of the portfolio.

Bond duration is one of the most important things you need to know if you are going to invest in them.  Duration is not only a measure of value, but a measure of risk. When interest rates rise, the value of assets fall.  That means if the Federal Reserve decides to hike interest rates .25% this week, Chicago can say goodbye to some of it’s $45M in savings.  If the Fed gets really active and starts continuing to aggressively raise interest rates, bondholders are going to get smacked.

I don’t think Chicago is alone when it comes to extending duration.  Municipal governments have been under a lot of pressure.  They look to save where they can.   Extending duration is an accounting gain on paper that allows politicos to report a better looking budget.  However, the true economic risk of extending duration isn’t reported.

If you think in terms of a big short-how do you short a municipal government?

  • Having some way to short munis would put much needed fiscal discipline into state and local governments. Too late now, though. It’s a long-only market, driven by a sell side army peddling mostly to retail widows and orphans. Combine that with whoredom — rating agencies, actuaries and underwriters paid by the issuers — and you’ve got the recipe for a calamity, which is now underway.