26 May 2011
It was a subprime lender that used a controversial accounting system called gain-on- sale, a system that was a red flag for short seller attention.
Novastar Financial was an enthusiastic participant in the housing/mortgage bubble of a time that already seems long ago. Gretchen Morgenson and Joshua Rosner have rescued Novastar from oblivion in their new book, RECKLESS ENDANGERMENT.
Here is a link to an excerpt from that book.
In 2004, at a time when the company's stock was worth $70, the Wall Street Journal printed a very well-written analytical story questioning the basis for its whole business model, which was offering high-risk loans to people with a poor credit record. Put so baldly as that, it seems obviously wrong. But somehow, at the time, that had to be said -- and the WSJ was sharply criticized for saying it.
The company took a stock price hit after the WSJ story came out, but for the most part continued along nicely (the "rising tide" of that era lifting all boats, including the least seaworthy) until February 2007, when it announced in its fourth quarter 2006 results a loss of $14.4 million, which was $0.39 a share. The general expectation had been a gain for the quarter of $0.73 a share. I'll do the arithmetic for you -- that's a difference of $1.12 a share, a heck of a failure to 'meet the number.'
Failing to meet the number by itself is not necessarily fatal. But in this case the attendent circumstances so perfectly confirmed what the shorts had been saying for three years -- that it had been meeting its numbers until then only by trickery which could not be sustained indefinitely -- that the end came very quickly.
During the period 2004-07, Novastar had a persistent message-board cheerleader who called himself sometimes Bob O'Brien, sometimes Easter Bunny. On a couple of occasions Bob the Bunny posted a list of the "most common basher myths," for example the "myth" that NovaStar was paying out in dividends more than it was earning, which was not sustainable. That "myth," like several of the others, happened to be true, but the Easter Bunny (who really is a myth -- oh nomenclatural irony, where is thy sting!) explained how to "debunk" it with various evasions about GAPP versus the IRS etc.
In February 2007, when Novastar made that disastrous fourth quarter disclosure, O'Brien finally saw the light. "I've been duped!" he cried! Not so much as a matter of expressing regret for the role he had played in duping others ... more a matter of ... what would you call it? ... whining.
He wrote this: "I have been body-slammed by this. Many of my friends are devastated by this. Some of my relatives, too. Personally, you bet. Very expensive lesson: Don't bet more than you can afford to lose. And don't bluff. I will not be buying anymore stocks in the U.S. markets, that's for sure. I'm quite done now. This casino has lost its allure."
Thus the grave has its victory. A story worth remembering.
Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.