Senate Invites Arsonist to Testify on Cause of Fire... Kind Of

After all that has happened with the financial crisis and the role that short-sellers played in dragging big companies down into the muck, you'd hope the U.S. Senate wouldn't play this role. But it is going on today.
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Sometimes the ways of Washington, DC are truly baffling.

In the U.S. Senate this morning a hedge fund manager gave testimony to the Committee on Health, Education, Labor and Pensions on a set of higher education companies.

The only problem is that the witness, financier Steven Eisman of FrontPoint Partners, stands to profit not from the success of higher education but from stock price declines of a specific group of companies in that sector. Eisman is a short-seller.

Most Americans would think investors lose money when stock prices go down. But a specific type of investor known as a short-seller makes money when stock prices go down, not up. Ain't America great? The companies go through the grinder, cut employees and investment while some guy on Wall Street gets rich.

The Securities and Exchange Commission explains short-selling this way:

A short sale is generally the sale of a stock you do not own (or that you will borrow for delivery). Short sellers believe the price of the stock will fall, or are seeking to hedge against potential price volatility in securities that they own. If the price of the stock drops, short sellers buy the stock at the lower price and make a profit.

This is exactly what Steven Esiman is doing right now, according to reports. While he is free to invest how he sees fit, the U.S. Senate HELP Committee shouldn't set the stage to help him cheer declining stock prices. Neither should any other part of the U.S government.

Eisman is best known from his role in author Michael Lewis' book The Big Short: Inside the Doomsday Machine for short-selling practices that helped crash the mortgage securities market. Bets against subprime mortgages helped FrontPoint double its hedge fund to $1.5 billion by the end of 2007. Eisman made his billions off of the crashed dreams of millions of homeowners. When he spotted housing trends he didn't blow the whistle -- he figured out how to get rich when it crashed.

Now Eisman is setting his sights on companies in the higher education sector -- often technical training schools like Devry or ITT Technical. This isn't just speculation about Eisman short selling higher education stocks. He has said it himself. During a May 26, 2010 speech at a hedge fund conference in Manhattan, Eisman promoted increased federal regulation of higher education as a means to assure that stock prices of higher education companies would fall by as much as 60 percent.

Get that? Steven Eisman wants the regulation of higher education to get rich -- not because it will be good for students or the schools. And now this hedge fund manager is leveraging a U.S. Senate hearing to take more short-selling profits.

A short-seller investor will always have a conflict of interest when speaking about a set of companies and that is why it is inappropriate to invite Eisman as an expert witness. He will typically always want to portray those companies in a bad light in order to generate news that would drive down their stock prices. His financial conflict of interest biases his testimony beyond redemption.

Could the committee possibly expect unbiased testimony? No. Eisman has staked a fortune on government action against higher education companies.

Worse than the conflict is that the entire Senate hearing plays into Eisman's strategy of creating a giant circus about higher education companies. The bigger the circus, the lower the stock price and the more money Eisman makes. The U.S. Senate shouldn't have a leading role in a Wall Street investor's "gambling" strategy -- especially a short-seller.

The threat a short seller represents to companies isn't false. The ginned-up threat of regulation or the suggestion of legislation has already been driving down the stock prices of these companies.

After all that has happened with the financial crisis and the role that short-sellers played in dragging big companies down into the muck you'd hope the U.S. Senate wouldn't play this role. But it is going on today.

It is an imperfect analogy but inviting Steven Eisman to a HELP Committee hearing on a sector he is short selling is like asking an arsonist whether a building will burn down. He'll say, "Yes" but that is because he plans to burn it down.

It is critical that the American people can trust that Wall Street hedge fund speculators and stock short sellers won't manipulate their elected representatives. They've caused enough damage to our economy already. No more Steven Eismans.

Update (10/6/2010):

There have been reports maligning the integrity of this piece. Because The Huffington Post community is important to me I would like to set the record straight with this update.

At the time I wrote this blog post there was absolutely no conflict requiring a disclosure. I do want to disclose that in August, roughly six weeks after I wrote this piece, a public affairs firm that I work in called LMG was retained by a coalition of privately owned schools. The firm's client is not the publicly traded schools at issue in my blog post, which are being targeted by short sellers. LMG has no publicly traded for-profit schools as clients as far as I know. I don't control whom the firm accepts as clients. My compensation before and after the firm was hired by the coalition is unchanged. I was on leave at the time the firm was approached by this coalition. However if the firm employing me, LMG, had already been retained by the coalition at the time of this piece I would have never written this post because it might be construed improperly.

Outside of my professional employment, a non-profit group that I started and serve as Chairman has in the past received funds from a consortium of many donors that I believe includes John Sperling, founder of the University of Phoenix and a major investor in solar energy. However there is no direct support for this non-profit from Sperling, the University of Phoenix or the Apollo Group. Reports to the contrary are absolutely false. The last time that donor consortium supported the non-profit was in 2009 to support the passage of strong and comprehensive financial reform.

Finally, I want to be clear for the benefit of The Huffington Post readers that the views I hold and write about are my own. I stand by every word in this post. I do believe that there is an inappropriate influence of Wall Street short-side investors in Washington. Some of them have allied with pro-regulatory forces in the progressive movement in a manner that exposes these progressives to criticism. While some short-side investors play an important role in the market, their influence in public policy is potentially not in the best interest of the public who may want to see strong, but regulated, companies. There are also some short sellers who run deliberate campaigns to crash companies that otherwise may be healthy. Making that point was and is the purpose of this post.

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