I have been talking about the short squeeze in financials all week. See The Financial Dogs Are Now Bitching About SEC Ruling.

Minyanville’s Todd Harrison has this synopsis of how it happened. Please consider Freaky Friday Potpourri: Anatomy of a Short-Squeeze.

Financial companies are desperate for capital but their stock prices are so low that any issuance would be dilution death for the companies. The government is desperately trying to keep the financial system together. Add that up and you get the possibility of a great manipulation.

How would the government engineer a rally in financial stocks so that these companies can sell stock to raise capital at a reasonable or at least palatable dilution level?

It might go something like this. Since financial stocks are in such trouble they have heavy short interest; this is natural and well known and can be used to their advantage. A clever “berry” might think to introduce confusing rules that raise the cost of borrowing short stock and temporarily confuse shorts into covering and not shorting more. And this is precisely what the SEC did.

It just so happened that the new SEC rules came conveniently the day before many of these financial companies were to report earnings. If just some how these earnings were really good the match would be lit on the kindling.

So far banks have miraculously come through on their end of things. Wells Fargo (WFC) and JPMorgan (JPM) reported better than expected beaten down earnings. Things must be getting better just as the companies need capital.

What a coincidence.

But if you look at how the banks “beat” their earnings the coincidence becomes clear. WFC took the unprecedented step of extending charge-off acknowledgment from 120 days to 160 days. And JPM was even more aggressive. It actually lowered its loan loss reserves quarter to quarter.

The list of financial companies where shorting regulations are being enforced/enhanced is precisely the banks and dealers (and FNM/Freddie Mac (FRE)) that have access to the Fed’s balance sheet (dealers through the PDCF and FNM/FRE through the recently-allowed access to the discount window). So we can speculate on the nature of the “coincidence”: Perhaps the Fed is getting worried about the value of all that collateral these dealers have posted to the Fed balance sheet and must boost the capital of these companies to protect that value.

And now on cue FRE, a $5 billion market capitalization company wants/needs to issue $10 billion in new stock? Doesn’t that sound a little crazy? Well get ready for others to do the same because the banking system needs capital desperately and the government is there to help.

But help at the expense of who?

Mike “Mish” Shedlock
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