TheStreet.com's Jim Cramer says a year of living dangerously almost destroyed Merrill Lynch and Citigroup.

To me the customers made out this time, the dealers didn't.

When I look at the losses the dealers are taking, I keep wondering how the heck they all got caught. Think of it like this -- if this merchandise were equities, you would ask: How did Merrill (NYSE: MER) (Cramer's Take) and Citigroup (NYSE: C) (Cramer's Take) get caught owning so much stock?

That's why we have to be shocked at the losses at Citigroup and Merrill. It was like they were making a big bet on housing and just masking themselves as dealers.

Now it is true that they were merchandizing and got caught. Prince was such an idiot. I hectored this guy and the board for a year, but all they did was stand by and applaud him. He probably had no inventory controls because he never understood the instruments anyway. That's OK, they were hard to understand. But he was the CEO, for heaven's sake.

Although short selling -- the practice of selling borrowed shares with the hope of repaying the loan by buying back the shares at a lower price -- goes against the American belief that stocks always go up, I have long been fascinated with it. Short Stories discusses what works, what doesn't, and what some of the leading lights in shorting stocks think about its opportunities and threats. I describe possible short trades and seek your comments and questions for story ideas. I don't offer any investment advice and I don't trade on any of the posts I write.

About 13 months ago, I suggested selling short shares of NovaStar Financial (NYSE: NFI) when it traded at a split-adjusted $116 a share. If you had followed that advice, you would have made a tidy profit -- it now trades at $1.79. If you covered your position today, you'd have a return -- before adjusting for the cost of margin escrow -- of 64x your investment.

According to The Associated Press, NovaStar laid off 85% of its people last week and its stock will be delisted on Thursday. Prior to the delisting, NovaStar had claimed that Wachovia Corp. (NYSE: WB), its lender, had given it a break by lowering NovaStar's minimum required liquidity from $30 million to $22 million.

In what could be a a key ruling for those of us hoping to learn more about shady subprime lending practices, a bankruptcy judge has given New Century Financial until February 6 to turn over a report of an investigation into the firm's cash handling practices to bankruptcy monitors.

Michael Missal was appointed by judge Kevin Carey to look into the accounting mistakes and/or fraud that led the firm to file false financial statement with the SEC in 2005 and 2006. According to the AP, "That report has yet to be filed. Missal said that continued foot-dragging by the defunct lender, former leaders and accounting firm KPMG will hold it up until March."

However, he has filed the report on possible cash mishandling, but it has not been made public at the request of New Century.

You would think that with its stock in the toilet, lawsuits alleging securities fraud pending, and a history of SEC inquiries, Novastar Financial (NYSE: NFI) would find it wise to start being honest with investors.

You would think. But on December 20, I wrote about the departure of Novastar's CEO, CFO, and general counsel. In the press release dated December 19 announcing their "retirements," Novastar wrote that Chairman and CEO Scott Hartman would "leave the Company and retire from its Board of Directors."

In the 8-K announcing the moves, filed with the SEC on the 21, Novastar said that "On December 18, 2007, Scott Hartman was terminated as the Chief Executive . . . On December 18, 2007, Gregory Metz was terminated as the Chief Financial Officer of the Company, effective as of January 3, 2008."

Why did Novastar change its language so dramatically? "Leaving the company" became "terminated" in a wonderful case of differential disclosure: 'Let's put out a broadly disseminated PR saying one thing and then file an 8-K with the SEC a few days before a holiday saying something completely different and hope no one will notice'.

Given that Novastar has already handed its shareholders massive losses, the least they could do is be honest and forthcoming in their press releases. But apparently, that's too much to ask.

Naked-shorting poster child/terrible company Novastar Financial (NYSE: NFI) has finally lost three of its top executives as it continues to flounder on the brink of bankruptcy.

Not so long ago (and by not so long ago, I mean 90%+ of the company's value), Novastar shareholders were blaming the company's sagging share price on naked short sellers.

Of course that turned out to be baloney, as the company was poorly-run enough to collapse on its own lack of merit -- no conspiracy theories needed!

What's fascinating is that it took so long for the chairman/CEO and CFO who presided over such destruction of value to resign to spend more time with their families.

If only Novastar shareholders had devoted more time to monitoring the company and holding management accountable instead of going off on loony conspiracy theories, this might have ended better.

When a stock declines from a reverse split-adjusted $250 per share down to $3.41 before heads roll, corporate governance and accountability are a serious problem.

TheStreet.com's Jim Cramer explains why "purchased HELOC" is the next phrase to fear.

Purchased HELOC.

Get that term into your head. Home equity loans that were purchased from other originators are the scourge of the system. Any piece of paper backed by these second liens that were issued by pure mortgage originators is just a goner.

This is the paper that was generated by Fremont General (NYSE: FMT) (Cramer's Take) and NovaStar (NYSE: NFI) (Cramer's Take) and New Century Financial and American Home Mortgage and so many of the other bankrupt and walking-dead companies. It was mostly no-documentation loans paper and served as another way to tap money that was meant to be paid back when you flipped a home. It was predicated on the continued increase in value of your home.

The New York Times provides some useful clues on how Goldman Sachs Group (NYSE: GS) was able to profit while its peers took enormous write-downs on holdings of Mortgage Backed Securities (MBS). Its culture encourages a healthy paranoia, which gives unusual power and pay to Goldman's risk managers -- and a willingness to act in conflict with clients' interests if it helps Goldman make more money.

The critical moment came late last year -- coincidentally around the time of my NovaStar Financial (NYSE: NFI) short call -- when Goldman's CFO called a "mortgage risk" meeting which concluded that Goldman should reduce its MBS holdings and buy expensive insurance as protection against further losses. Despite this strategy shift, Goldman continued to package risky mortgages to sell to investors. Many of these clients took losses while Goldman made money. (I think if it was truly concerned about its clients' well-being, it would have warned them of the dangers it saw.)

Goldman has a relatively flat management hierarchy which allows people closest to the markets to get their views heard. And one of the keys to adapting to risk at Goldman is the unusual power and pay of its risk managers. Its controller's office, the group responsible for valuing Goldman's huge positions, has 1,100 people, including 20 PhDs. If there is a dispute, the controller is always deemed right unless the trading desk can make a convincing case for an alternate valuation.

TheStreet.com's Jim Cramer explains what could force the Fed to cut rates again.

The housing index just can't rally for a minute. The thing's amazing. The stress of the system is so clearly manifested by this that I have to wonder if the Fed wants this index lower.

The fact that the Fed's speakers never mention things like this index and the homebuilders makes me wonder if this group is actually what the Fed wants to put out of business. I wonder if the Fed thinks that Pulte (NYSE: PHM) (Cramer's Take) and Horton (NYSE: DHI) (Cramer's Take) and Lennar (NYSE: LEN) (Cramer's Take) and Standard Pacific (NYSE: SPF) (Cramer's Take) and Centex (NYSE: CTX) (Cramer's Take) need to go bankrupt before the Fed can ease any more.

Many of these firms lent money recklessly. Are the Fed heads thinking these companies need to pay like the New Centurys and the NovaStars (NYSE: NFI) (Cramer's Take) did? (Are the feds, by the way, thinking that this GMAC company has to go because that was a huge provider of crummy mortgages?)

JC Penney (NYSE: JCP) is trading off almost 4% after cutting its holiday sales outlook.

InfoSpace (NASDAQ: INSP) is up 7% after announcing a special dividend.

Telestone Technologies (NASDAQ: TSTC) is trading up 26% on strong earnings.

Advanced Life Sciences (NASDAQ: ADLS) is up on news of a successful trial of one of its drugs.

Sina (NASDAQ: SINA) is down 10% on weak earnings.

NovaStar Financial (NYSE: NFI) is down 39% on poor earnings and the possibility that its shares could be de-listed.

Stocks trading in the pre-market may open at different prices in the regular session.

Douglas A. McIntyre is an editor at 247wallst.com

As Peter Cohan discussed earlier, shares of Lululemon Athletica (NASDAQ: LULU) awere down more than 8% [earlier] today. A New York Times article mentioned that the seaweed content of Lululemon products, which are labeled as being made of 24% seaweed, is actually 0%.

According to newspaper, "The Times commissioned its test after an investor who is shorting Lululemon's stock - betting that its price will fall - provided Chemir's test results to The Times."

Short sellers get a lot of grief, but this story provides evidence of why I respect their research so much. Sell-side analysts operate on a research method based on trust; they generally parrot the claims made by management, and have well-deserved reputations for downgrading stocks after they lose most of their value.

What a fantastic time to own oil, gold, or any currency other than the dollar! And what a wonderful world it must be for foreclosure lawyers! How can you profit? Buy non-dollar currencies, lock in your heating oil price, and consider shorting mortgage insurers.

The statistics are mind-numbingly awful. The price of oil hit a record $96 a barrel, up 300% from $24 in January 2001. Gold is near a record high at $800, the dollar is at record lows -- for instance it takes $2.08 to buy a British pound. Housing, which has been tumbling from its peak in August 2006, is hurting too -- with foreclosures up 100% in the last year. And the mortgage meltdown has led to big layoffs -- my firm counts 70,087 finance layoffs by 42 companies so far this year.

There are three ways you can profit from this trend. First, you can buy currencies -- like the pound and the Euro -- which are getting stronger as the dollar weakens. Second, if you heat your house with oil, you can consider locking in a fixed price -- because oil is clearly going to keep going up.

It's amazing that it took Novastar Financial (NYSE: NFI) this long to announce it, but now it's official: The company scrapped its plans to pay a dividend on its 2006 "profits", and will therefore have to forfeit its status as a real estate investment trust.

The company expects the new tax status to have a "significant adverse effect" on its third quarter results.

This is a great time to give a shout out to BloggingStocks' own Peter Cohan, who had one of the best short calls I've seen in a long time. In a brilliant post on December 18th of 2006, he wrote that "Potential loss of short-term liquidity could make it tough for NovaStar to repay these debts." He suggested that investors short the stock, and the stock is down more than 92% year to date. Great call Peter!

At the time, many were complaining that the company was a "victim" of naked short selling. Obviously, short sellers were the least of Novastar's concerns, as the company is currently fighting for its life.

The New York Times [registration required] reports that American Home Mortgage Investment Corp. (NYSE: AHM) is shutting its doors thanks to the fear of its lenders -- who provide the wholesale money they lend to home buyers -- that they won't get their money back. Doug McIntyre posted about this here. Several of AHM's peers -- IndyMac Bancorp (NYSE: IMB) and Accredited Home Lenders Holding (NASDAQ: LEND) -- are also in rough shape.

Last October, I began looking for ways to profit from the collapse in the housing market. My best idea -- posted in December -- was to short shares of NovaStar Financial (NYSE: NFI) which dropped from $116 to $7.19. This post got the attention of a reporter from NPR's MarketPlace who dropped by my office this week to interview me about where the next opportunities for short profits might lie.

My answer is that I don't know. That's because the hedge funds, endowments, pension funds, and insurance companies that buy the mortgage backed securities (MBS) constructed from the loans that NovaStar and its peers originate are not disclosing the value of their MBS holdings. To identify short selling opportunities, I'd like to know this information because many MBS holders will be wiped out.

Last March, I wrote a post which suggested that the mortgage insurance industry would take a hit as a result of the subprime mortgage meltdown. Today's New York Times [registration required] suggests that prediction was correct -- two leading mortgage insurers are writing down the value of their subprime mortgage subsidiary.

Specifically, the Mortgage Guaranty Insurance Corporation (NYSE: MGIC) said last night that it would write down its $516 million investment in Credit-Based Asset Servicing and Securitization (C-Bass) -- possibly to zero. Radian Group Inc. (NYSE: RDN) which has a $518 million stake in C-Bass, also said it might have to write off its investment completely.

Meanwhile, NovaStar Financial Group (NYSE: NFI) whose subprime mortgages MGIC insures, has fallen 91% to $10.83 from the split-adjusted $116 at which it traded in December when I suggested shorting it.

Computer Sciences(NYSE:CSC) call volume and volatility spikes on renewed speculation. CSC is recently up .97 to $61.27 on unconfirmed deal chatter Blackstone(NYSE:BX) or Hewlett Packard (NYSE:HPQ) will make a bid. CSC is frequently chatted as being sold to IBM (NYSE:IBM), Lockheed Martin(NYSE:LMT), United Technologies (NYSE:UTX) or private equity after Apollo Managements' bid for the CSC failed in the spring of 2006. CSC July 62.5 calls have traded 126 times on transaction volume of 3,459 contracts above its open interest of 2,356 contracts. CSC August option implied volatility of 36 is above its 26-week average of 25 according to Track Data, suggesting larger price fluctuations.

Option volume leaders today are: Novastar Financial (NASDAQ:NFI) and Apple Computer (NASDAQ:AAPL).

Daily Option Update is provided by Stock Options Specialist Paul Foster of theflyonthewall.com.