Authors: Carey Green
“That’s not so hard,” Vanessa said.
“So, do you have something for me?” Dylan asked.
“Yes.”
Conroy took out a black portfolio and placed it on his desk. From inside, he took out several pieces of paper and pushed them towards Dylan. The young trader picked them up and looked them over.
“So?” Conroy asked.
“This doesn’t tell me anything: IBM, Ford, Xerox. These could technically be shorts without locates, but these are easy names. No one would care, not even the Exchange.”
“Meaning?”
“It’s like this,” Dylan said, as he took out a pen and flipped over a sheet of paper.
“If you short a stock like IBM without a locate, no one cares. These are ‘easy to borrow’ stocks. There are over a zillion shares of IBM in the world, so you can borrow the stock from any bank or broker. You have no problem getting it, so the locate is merely a formality. A problem stock is a small company that everyone wants to short, like Taser. The stock went from ten dollars to one hundred in a week, then for some reason the bubble burst. Every fund wants to short it, but there are no shares in the marketplace. Why you ask? Well, in a newer company like this, most of the stock is still tied up in the owners of the company, or maybe the private equity funds that helped them go public. Now, these people are not going to loan you their shares because it’s not in their best interests for the stock to go down. So the few shares that are floating in the marketplace are very difficult to get, and you can’t short the stock without it.Understand?”
“Yeah,” Conroy said. “I knew it.”
“Well,” Dylan asked gruffly. “Do you have any examples of ‘difficult to get’ stocks?”
“Not yet.”
Dylan laughed. “This is what you needed information on? You could have taken me out for a cocktail. I would have explained this for a song.”
“We haven’t compiled everything yet. This is just a sample. But since you’re here, why don’t you explain naked short selling to us in your words. Maybe I’ll buy you a cocktail afterwards.”
Dylan then walked them through a thorough explanation of the hedge fund industry: how funds operated, the role of the prime brokers, and the landscape of the industry in general. Much of it was arcane technical details. Vanessa and Conroy took copious notes. At the end, both had a host of questions that Dylan tried to answer.
“Why is this industry so loosely regulated?”
“Lots of reasons. Let’s start with what a hedge fund is. Unlike a mutual fund, which is highly regulated, a hedge fund is an unregulated entity designed primarily for wealthy investors and financial institutions. Obviously, the topic has gotten a lot of attention lately, but ten years ago only a few super-sophisticated investors even knew what a hedge fund was. Then, during the dot-com boom, these guys became rock stars. Money flew in like a tornado. When the funds got big, they hired lobbyists in Washington to argue for their interests, and with a Republican administration, business is always first. Also, some of these guys are super-secretive. They don’t want people to know what their strategy is, or their mathematical formulas. Trust me, some of these guys have genius-level IQs, and if they had to disclose their methods, someone would surely find a way to reverse engineer their strategy. Which brings us to the present.”
“Today you have over one thousand funds. The industry has evolved in such a way that you now have investors with patient money such as pension funds, retirement funds, even some state and local governments became attracted to the double- and triple-digit returns that some of these investment managers offer. So people blindly put money into these guys, and expect them to produce fantastic returns. It’s as simple as that.”
“And you think some of these funds are fraudulent?”
“No,” Dylan said. “You do. I thought that was why I was here. But if you’re asking my opinion, I read the papers. White collar crime is rampant.”
“You’re right,” Vanessa said. “These funds can do almost anything these days. They can spread rumors that cause stocks to go down, or they can just take the money and disappear. There’s no one to stop them.”
“I thought that’s what you guys were doing.”
“We will.” She smiled at Dylan then at Conroy.
“Of course,” Conroy added, “I appreciate you coming to talk to us here. It’s useful information. Can we count on you further if we need additional information?”
“Look, I’ve done my part,” Dylan said. “but you’ve shown me nothing. So, that’s it. If something pops up, I’ll call you.”
“Thanks for coming anyway. You need a lift uptown?”
“Actually, my gallery is around the corner,” Vanessa smiled and raised an eyebrow.
“What kind of a gallery?”
“An art gallery; a little one,” Dylan said. “It’s not far from here. We’re having an opening.”
“Ooh … Sounds fancy.”
“Nothing of the sort,” Dylan said. “We’re trying to drum up some business.”
“Open to the public?” Vanessa asked.
“Anyone willing to buy art.”
Vanessa looked at Conroy who shrugged. “I’m heading home. Gotta’ walk the wife’s new puppy.”
“Hope he didn’t pee on the sofa again.”
“Me too,” Tim said.
“What kind of puppy?” Dylan asked.
“A Viszla. My wife had them as a kid.”
“I know the breed,” Dylan said.
“Not many people do. Are you a dog person?”
“No,” Dylan said. “I have a cat.” Vanessa raised one eyebrow.
“You have a cat?”
“Shocking?”
“Not at all. I’m a cat person. Just surprised you have one. Does the cat paint?”
“No, the cat does not paint, but it’s named Picasso. ”
“Named Picasso?”
“It’s a cute cat.”
“I’m sure it is.”
The gallery was packed and aglow. Stylish women in summer dresses and men in dark suits were drinking mail-order champagne from glasses purchased at Pottery Barn. A makeshift bar had been erected near the rear of the gallery, and Samantha, dressed in a bright summer yellow dress, was rushing back and forth, filling guests’ glasses and expectations. Dylan had rushed in, scattered a few hellos, and left the room as quickly as he had entered.
The featured artist that night was Kenneth Lowman, a young Californian who had painted a series of wall-sized landscapes depicting the Old West, complete with wild horses and rustic western saloons. His work was becoming both popular and expensive, and it had been a real coup for Samantha to snag him. The art economy was still dreadful, and despite the eager crowd, there had been no sales so far. Samantha, almost foolishly, had placed her expectations that a successful show might make the gallery whole financially. As the date of the opening approached, she had become far more skeptical.
After his meeting with the FBI, Dylan had snuck into the gallery’s office and slammed the door him behind him. The meeting had scared him straight, though they had shown him no real concern. His immediate desire was to quit the hedge fund, but doing so would lead to financial ruin. He felt under his arms, and realized his shirt was soaked. Perspiration hung heavily from his brow, and he reached into the desk drawer and removed a fresh white shirt. He put the shirt on, but was still sweating. He saw his reflection in a small decorative mirror in the corner of the room. He looked like a ghost. He began to wonder how he would make it through the party.
Dylan turned on the computer and brought up an Excel spreadsheet with the gallery’s finances on it. After paying Neuman his back rent, and several other past due bills, the gallery would still be in the red for over 75K. Dylan flipped the spreadsheet to a tab that contained his own finances. He had enough cash to maybe scrape by for six months. His stock portfolio had been cut in half, most of it in stock from his old company that he couldn’t sell for another year. The mortgage on his apartment was underwater, leaving him liable for at least another million and change. Shit! He slammed the monitor off with his hand. How had he let things get so bad? He was lost in these thoughts when Steve Neuman opened the door.
“What are you doing? Brooding?” “Sort of. Come in. Have a seat.”
Dylan got up from the chair and pulled a document from the printer. He sat back down, retrieved a pen from the desk, and signed the document in front of him. He then placed it in an envelope and handed it to Steve.
“Here’s the back rent, plus the upcoming rent that’s due next week.”
“Wow,” Steve said, his face filled with surprise. “I wasn’t expecting this.”
“I didn’t think so. Neither was I a week ago.”
“Thank you much, sir. This thing isn’t going to bounce on me, is it?”
“I like you, Steve. I only bounce checks to people I don’t like.”
“That’s good to know.”
“You want a glass of wine? After all, it’s a party.”
“Any good?”
“Sure. Best mail-order wine money can buy.”
Steve laughed. “Sure. I’ll have a glass.”
Dylan retrieved a bottle of wine. Reaching into Samantha’s desk, he took out a corkscrew and removed the cork from the wine. He poured the wine into two plastic cups and handed one to Steve.
“How did you pull this off?” Steve asked.
“Buy cheap wine?”
“No, the check.”
“Oh, I got a signing bonus.”
“In this economy? Boy, you must be a genius.”
“Not a genius. Just got lucky, I guess.”
“Not a lot of luck on the street these days.”
“Please, I know so many well-educated people who are unemployed. It’s ridiculous.”
“Times are tough.” Steve took another sip of his wine. “I want to ask you something.”
“Sure. As long as it’s not about my old job.”
“No, it’s not that,” Steve said. A bewildered look came over his face. “I wanted to ask you about derivatives.”
“Derivatives?”
“Yeah. How do derivatives work?”
“You mean, financial derivates? That’s a big subject, and one not usually discussed over wine in an art gallery. Besides, don’t you deal with this at work?”
“Uh, no. My specialty is airplane leases. How does this stuff work?”
“Sure. I’ll give it a shot. On the simplest level it’s pretty easy. A derivative is simply a financial contract whose value is generally determined by something else. For example, mortgage-backed securities. Those are derivatives. Imagine if someone has taken a thousand mortgages, big and small, risky and non-risky, and packaged them into one big mortgage. Then you take that big mortgage, and you sell it off in little chunks. That’s how credit works. When somebody buys a house, the bank doesn’t keep that loan forever. They might for awhile, but typically they would sell it to someone else, who would do the same thing, on down the line. The bank extends credit, but they also can’t always wait thirty years to get their capital back. So they sell it to someone else. Way back when, that’s how banks did it manually. They used to actually sell each loan, one at a time. So when derivatives came along, and they were now able to buy and sell thousands of mortgages bundled up as one, it became very useful for them. They could focus on the lending business, knowing that there was a means of repackaging and selling the loans on a large scale. They use computer models to create these baskets, And in theory, it makes it less risky, because you are buying a small piece of thousands of loans that have been balanced between large and small, risky creditors, and non-risky creditors. Of course, now we’re learning that some of those models didn’t work so well.”
“So what’s the answer?”
Dylan picked up his glass and took a sip of wine. “You mean, ‘How to fix’ what’s going on in these markets?’” Dylan shrugged. “Who knows? A lot of people smarter than me can’t figure that out, so I sure don’t have the answers.”
Steve got up and began to pace around the room. Dylan watched him as he walked away from the desk and towards the window.
“I’ve lost a fortune by not selling this building. Two years ago, I had an offer on the table for almost ten million dollars. Today, I don’t think I could get five.”
“Five is still a lot of money. I’ve lost most of what I’ve earned in the last few years.”
“That money is not just for me, Dylan. There are a lot of people expecting a piece of that. Some of them won’t take to kindly receiving a fraction of what they anticipated.”
“It’s still Soho. Manhattan is not going away. If you hold onto it, it will come back.”
“I hope so,” Steve said. “I hope so.”
“Hope is all we can do right now. Some people can’t even pay their bills.”
“I know. I shouldn’t be complaining.”
“It is what it is. I went through this after 9/11. The markets were in shambles. After that, I swore that I’d put my financial house back in order. Now, I’m back where I was five years ago in the same damn place, and I don’t have the stomach for it anymore.”
“Maybe you should find a new line of work?”
“Doing what? I’m thirty-five. All I’ve done since I got out of school was trade. I could teach high school math. Nothing else comes to mind.”
“Start a business?”
“That’s a great idea. In fact, I think I’ll start an art gallery!”
“Yeah,” Steve said, with a chuckle. “There’s an easy way to make a fortune.”
Dylan shrugged as if to say never mind. He then got up from his chair and grabbed the wine bottle. He dangled it over Steve’s glass as he began to pour.
“I’d like to propose a toast,” Dylan said.
“To?”
“To better times,” Dylan said. “And when better times come, as they always do, you and I will find more meaningful ways of living our lives.”
“
Salut
,” Neuman said, as they lifted their glass and drank. They heard a knock at the door. Laurel stuck her head in.
She was twenty-two, red haired and freckled, and the only paid employee of Silverlight galleries. During the day, she was an Art History student at NYU, and thrilled to be working in a New York gallery, albeit an unsuccessful one. She had volunteered to work for free; her family apparently was affluent, but Dylan had decided to pay her a small hourly wage.
“Dylan,” Laurel said. “
You
have a guest.”
“Is it Binky?”