Monday, April 18, 2022

Stock Price Manipulation - Another Sign of the End Times?

When markets become little more than casinos, we are in trouble.  When they become rigged casinos, we are really, really in trouble.

Recently, Elon Musk violated SEC rules by buying more than 5% of Twitter stock without disclosing his buy to the SEC.  The theory is, if someone is buying up a company, the rest of the world has a right to know - before they sell or buy the stock themselves.  By failing to disclose his purchase, he picked up the stock at a lower price than he would have, if people knew he was buying.

But it gets worse than that.

The SEC fined him a trivial amount - compared to the tens of millions he stands to make.  It is like that pump-n-dump kid from New Jersey back in the 1990's.  When the SEC fined him a hundred grand, his only reply was, "do you take a check?" because he made far more than that, pumping penny stocks.

But it gets worse than that.

Musk then went on to say he wanted to take Twitter private with an offer of $54.20 (get it? 420 - as in "smoking pot!' tee-hee!).  He used the same "420" gag when he pumped up Tesla stock a few years back, claiming there was a "firm" buyout offer (there was not) and again, he was fined a trivial amount by the SEC.  Well, not trivial to us mere mortals.  A rounding error to Musk.

Of course, the buyout was a canard.  The major shareholders, including some Arabian investment funds, said "no thanks!" to Musk's offer.  So it is going nowhere.  To top it off, Twitter enacted a poison pill provision, so the whole thing is dead in the water.

So, Musk failed?  Hardly.  Once his "buyout" offer of $54.20 a share came out, well, the price of the stock went up even further.  So at this point, his initial investment to buy 9% of Twitter has increased in value by tens of millions of dollars.  How did he do this?  He made a few Tweets.

Now, before you get all up in arms about this, bear in mind that the people who bid up the price of Twitter stock (and Tesla stock, before) were not the savvy investment bankers on Wall Street (and if they did, who cares about them?) but rather retail investors who watch television and financial channels and think, "That Space Jesus guy is alright - he knows what he is doing!  I'll buy $500 of Twitter stock tomorrow!"  And by doing so, the "last idiot in" sets the stock price - not the whale investors.

Was the whole "Twitter buyout" thing a fraud from the get-go?  Well, it certainly looks like it and a lot of other people such as Mark Cuban (himself a piece of work) have made similar noises.  It is a pretty obvious play.

Win or lose, Musk makes money - with little effort on his part.  Actually, "losing" ends up being more profitable than winning, as actually taking Twitter private and trying to run it to make a profit would be hard work - and the profits thin.  Yes, Twitter isn't profitable quite yet - although it has shown some profits in some quarters back in 2018 and 2019.  So Musk would be better off losing his bet and then selling the stock - at a nice profit, of course.

Or not selling.  If you sell stock, you have a capital gain and you have to pay taxes on it - particularly short-term capital gains, which are usually taxed at a higher rate (it used to be 25% versus 15% which is quite a spread!).   So how does Musk make money if he doesn't sell?

Well, that's an interesting question and maybe one way the mighty Musk empire may crumble some day.  Much ink was spilled a few years ago how Elon Musk and other Billionaires don't pay any taxes, even as they made a lot of money. The way they avoided - or at least delayed - taxes was perfectly legal.  You only pay capital gains tax on a realization event - the sale of a stock or other asset, for example.  So if you buy $1000 worth of stock and it goes up in value to $2000 you have no taxable income until you sell that stock and realize the gain.

But you know, the Ferrari dealer doesn't accept stock as payment.  So what you do is borrow against your assets, which at the low, low interest rates of the last few years, was rather attractive.   Banks were eager to loan Billionaires the money as they had "blue chip" stocks to use as collateral.  Hey, Tesla stock is a sure thing, right?   So you borrow against it, pay 1-2% interest on the loan and pay no taxes.  Seems pretty simple - you don't pay taxes on loans, as loans are not "income."

(I digress, but this is why Biden and other Democrats are proposing a Billionaire's tax to force people who make over a hundred million a year to pay taxes on gains, even if there is no realization event.  Sounds appealing to the folks in the cheap seats, but it would be a nightmare to tax unrealized gains and keep track of them (and losses as well!) over the years.  The only people making money off that are tax attorneys!)

Of course, Musk had to sell some stock last year - likely to make payments on those loans.  But the amount he sold was trivial (to him, anyway) and even if taxes were paid, likely they were far less than the amount he would have paid if he sold stock to raise money instead of borrowing against the stocks.  As we learned in law school, a tax deferred is a tax denied.  Hence the beauty of the 401(k) and IRA - you have 30 years to play with Uncle Sam's money before you have to cough it up in taxes - and often at a lower rate as well.

And even us little people can play this game, too.  For example, some folks have life insurance policies with loan provisions.  You go to retire and instead of paying taxes on your life insurance policy (by cashing out) you borrow against it instead.  Provided the interest rate is fairly low (mine isn't - 8%!) it might be a better deal than paying income tax.  For a large policy, if you cash it out, it could put you into the highest brackets.  Since this play doesn't work for me, I plan on just cashing those dividend checks and when I die, the insurance payout will go to my next of kin.   But I digress.  Yet again.

There is a small problem with this borrowing-against-assets model, however - and that is all loans have to be repaid, eventually.  If you can keep the loan going until you die, well, you may avoid the tax-man, at least during your lifetime.  But even at 1-2% interest rates, the cumulative interest could add up to quite a sum.  And with interest rates going up to 5% or more, well, it could get messy.  And you can bet your britches these asset loans are variable-rate and callable as well.

Margin players run into this all the time.  You want to make a killing short-selling "Gamestop" stock, so you buy an option to sell the stock at a lower price later on.  Problem is, most brokerage houses want some sort of collateral backing up your option in case it goes horribly wrong.   So you pledge your investment portfolio as collateral and place your bet - literally - on where the stock price is going.  Then some idiot on Reddit decides to encourage small investors or "apes" to buy single shares of Gamestop, driving the price UP even as the company circles the drain.  Again, share prices are not rational - they are often emotional.  The last idiot in sets the share price.

So your option comes due and you have to buy those shares you shorted - at a much higher price - to sell them at the low price you agreed upon.  You are out hundreds of thousands of dollars - maybe millions if you are some hedge fund manager.  The brokerage house then sells your other stocks to make up the difference.  Since they are selling off huge chunks of stock, the price of those tanks, which means they have to sell even more.  Shit like this can cause markets to crash.

Now apply this to the Musk scenario.  If he has borrowed against his holdings (as so many Billionaires do to avoid paying taxes) and the loans come due or are called or the interest rates skyrocket, then the Billionaire has to sell off shares to make payments on the loan.  Selling off big chunks of stock depresses share price.  The "founder" of the company selling off big chunks scares the crap out of the market.  So he has to sell even more to pay off his bills - and it snowballs downhill from there.

Borrowing is leveraging, and levers are simple machines.  "Give me a big enough lever and I can move the world," Archimedes supposedly said.  A small force on one side can cause great movement on the other.

So, I could see a scenario where even a high-flying Billionaire could end up broke, over time.  With all the electric cars hitting the market right now, can Tesla survive?  Studebaker pioneered the compact American car market in the late 1950's and had the market to itself - and was profitable for a few years.  But by 1960, the "Big-3" came out with compact cars of their own, and Studebaker was history.

Tesla is Studebaker.

You're Gimbels, Marge!

But what about solar city?  Home storage batteries?  SpaceX?  Surely they will keep Musk afloat, right?  Well the Solar City deal turned out to be a nightmare for Tesla and people have accused Musk of insider dealing as a result.  Cheap Chinese solar panels - even with Trump tariffs - have flooded the market.  Changes in solar panel subsidies have made home solar a non-starter. And as for home battery packs, well, anyone can make a lithium-ion battery pack.  There are no moats here.

And as for SpaceX, well, one Challenger incident is all they need to see a major blip in their revenue.  Since SpaceX is privately held (by Musk) we have no real idea if it is even profitable.  And quite frankly, given the fast-and-loose way SpaceX plays, I suspect such an incident might occur in the near future.  Space exploration is a highly dangerous business, no matter how you slice it or how cool your "space suits" look.  You are sitting on a tower of volatile fuels, blasting off into a near vacuum where death is all around you, returning to earth in a fireball of flame.  What could possibly go wrong?  It is like air travel but 100 times more complex and dangerous.  So long as everything works perfectly, no problem.

What will happen is anyone's guess.  But the overall thing that concerns me is that this sort of stock manipulation by tweet isn't creating any real wealth.  It is just rearranging money and gambling on stock prices going up or down because people believe them to be so.  Profit and loss are a thing of the past, we are told - and were told the last time "dot com" melted down.  That Billionaires can get away with such blatant manipulation of the market will cause ordinary investors to lose faith in stocks.  And as I noted in an earlier posting, the whole market for investments (or any market) is based entirely on faith.

Yes, the value of the dollar is based on a communal understanding and agreement that we all think it is worth something.  The same is true of Bitcoin, the problem for Bitcoin is far fewer people believe in it, and given its volatility and history of fraud, theft, and abuse, it doesn't seem like the majority of us will give it much faith in the future.

(I digress yet again, but Musk made another killing by saying Tesla was going to accept Bitcoin as payment and was buying Bitcoin.  The price of Bitcoin went up, Musk sold out, made tens of millions of dollars just for a few Tweets.  Pump... and Dump.   You know, Trump should take lessons from this guy!  Trump never made a nickel from a Tweet!)

When the whole stock market seems like a rigged game for Billionaires to play, what's the point in playing?  Many small "retail" investors - who do drive these stock spikes - will become disillusioned and turn away from the circus.   Or perhaps not.  Perhaps they will just stop buying stocks as they run out of money to throw at these things, as the cost of living skyrockets and they get burned one too many times by a "sure thing" investment.  Once your victims are bled dry, there is nothing to be gained from bleeding them further.

And it could happen in a very, very short period of time.  We saw this in 2008 when overnight, it seemed, people when from being crazy about owning houses to wanting to unload them at any price - or simply walking away from them and defaulting on their mortgages. Something highly coveted and valued one moment, worthless the next.  And this took out the mortgage-backed securities underlying all these deals, which in turn took out the greater market, as again, many were forced to sell due to margin calls and the like.

It is sad, but Elon Musk didn't make money by making electric cars or rocket ships - those were made by the employees and engineers of Tesla and SpaceX.  Musk made money by taking the fortune he started with and then leveraging it time and time again, to make more money.   It is a way to end up with Billions, of course.  But leveraging works both ways.  When all their wealth is tied up in stocks and they owe as much in loans, they may not be as wealthy as it may appear.

Think of it this way:  In 2008, we had middle-class people who owed $250,000 on their house, which was "worth" $500,000 due to the bubble market.  They also had a portfolio of mutual funds in their 401(k) worth $500,000.  On paper, you might argue they are millionaires, but for the mortgage.   But when the shit hit the fan, the house was worth less than the loan balance, and their 401(k) dropped by more than half as well.  Turns out they were insolvent the whole time.

Now take that model and add a few zeros to the numbers and you've got Elon Musk or any other modern Billionaire.