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Saturday, May 09, 2009

Naked shorts

I've been reading about naked short selling. Jesus. Why was this shit ever legal? It's a recipe for ruining an economy. It gives investors an incentive to destroy corporations!

See here and here and here and here and here and here.

A week ago, I was wondering why the economy is as bad as it is. Now I'm wondering why it's as good as it is. How the hell have we survived so much legalized plunder?

Back when I first began my investment firm, I considered the question of whether I would short-sell the stock of any company even if I felt it should or deserved to fail. I quickly concluded, no, it wouldn't be moral for me to make money that way. I am ok with making money off of outguessing or "out-informing" someone, but not off of their misfortune, no matter the circumstances.

Sergei Rostov
"Withdraw from a rigged game" is exactly what I'd to see more people do. I feel that investing in your local community and businesses is the ideal way to achieve economic stability for both yourself and your community. When you put a personal stake in it, you also tend to care a bit more about its future and have to take a longer view. That's alien to people whose concept of investment is watching a march of numbers from one quarter to the next.
Relevant Bloomberg piece:
I got no problem with short selling. Naked short selling I can see potential problems with, particularly if other laws are being broken - like conspiracy, fraud, insider trading, or buying of influence or "news" stories.

There used to be an old saw, "He who sells what isn't his'n, must buy it back or go to prison". Its bloody dangerous stuff shorting stocks. Tricky work.

What exactly is wrong with shorting borrowed stock? Its the financial equivalent of calling "bullsh*t" on erroneously high stock prices.

Pat Byrne is as "questionable" as the guys.

As far as I'm concerned, most short sellers are performing a public duty. Its the evil sobs who promote and push long stock positions into the general public who are doing more damage.

I dont mind losing money. I mind being cheated or defrauded. Generally it aint short sellers doing that. Short sellers didn't make Enron or WorldCom, or sub prime. They were the guys who told the world it was going on when journalists weren't interested or had been bought off.

Naked short selling - ie without borrowing stock, should leave you open to litigation for failure to deliver. And it should result in the short position being bought in. You would do better to ask why that sometimes doesnt happen to firms like Goldman. Why one law for some and another for others?


Did you read the 2nd link that Joe provided.

Short selling and naked short selling should be band for one reason, they are easily corrupted and can force the price of a company down below where it's market value may very well be.

Item #2
You can't sell what isn't yours. Unless you can come up with an analogy that in the real world, not the fiction that finance provides, but in the physical universe we live in, There is just no way you can sell what you don't own. It looks like a criminal enterprise to us 'ordinary folks'.

Harry, however you boil it down, short-selling is not only betting on someone else's failure -it's essentially the same thing as that "stock exchange" started several years ago where people can lay odds on the next occurence of a natural disaster or terrorist attack. As if this weren't bad enough, morally and ethically since the market is based on perception, short-selling in and of itself actually pushes companies closer to their end: If a bunch of traders wanted to, they could destroy WeSavePeopleFromDrowning Inc. just by shorting it. And justifying it by claiming a stock's price is inflated doesn't wash, either, since you couldn't know that unless you had insider information...and trading based on that is illegal (for obvious reasons).

Sergei Rostov
Joe - Thanks for putting this in your mindspace, you might find it will be connected to many of the criminal side-shows which offend and entertain us. It is also interesting when a literal conspiracy moves from theory to proven as is essentially the case with the media manipulation here.

Harry - I'm with you, short-selling can be a public service, naked short-selling, evil. Where was oversight?!?

Sergei - You're my favorite poster here, but don't you think we need some balance to the overwhelming cheerleading done by the financial press and media? I think short-selling accomplishes this, one must always be able to bet that things will go down. Phantom shares and media conspiracies notwithstanding.
Dudes, glad to debate the point.

1) "Naked" short selling a bank is potentially questionable - although up until quite recently you wouldn't have gotten very far if your objective was to reduce confidence in the bank.

But how exactly does one bring down a perfectly healthy company by selling its stock below its "true" value.

I can see that it might be harder for the company to refinance its debts. But if its capital structure is so strung out that it cant refinance, are you sure the company is so healthy? Are you saying that all corporations have the god given right to access cheap capital regardless of their capital structure?

If I sell you something cheap Im doing you a favor. How exactly is my selling you cheap IBM stock going to make IBM collapse. Go on, tell me? This logic only works if the company is NOT sound. Thats when covered short selling can reduce the life expectancy of a company.

2) The thing about shorting stocks is that generally you are going against the interests of the company insiders. Very dangerous game. They have all sorts of things they can do to you. All you can do is try and publicize your bear case.

Obviously sometimes the shorts carry a very big stick. But money center banks carry big sticks too. This is not an unequal game of david and goliath. The shorts in the case of the US banking system were in effect saying that the banks were over their skis. Who was right?

Commerce is easily corrupted. So are elections. So is sex. That doesn't mean we should ban them. Same with covered short selling. Who is gonna sell you the stock you need if they cant short it? Eliminate shorting and you eliminate market making. Which should raise the cost of capital for all. You would be left with a broked market - and thats NOT going to be more transparent.

Of course you can sell what isn't yours currently. People sell stuff they plan to own all the time. Insurance for example? When you buy a house you borrow money (unless rich). You dont own that money. You plan on giving it back in the future. Well why shouldnt people borrow stocks if you can borrow money? What is collateral if it isnt borrowing stocks (or real estate) against money?

If you want to bet on an endevours success then you need someone else to bet on its failure. If you want a liquid stock market then you will need people to be prepared to sell you stocks they dont own and then run around trying to buy them back. That adds to liquidity.

If WeSavePeopleFromDrowning Inc .com cant make money then the system will make it go bust. If on the other hand it does make money, then shorting the stock will tend to result in the short going bust. Its anyones guess whether the price is too high or too low, but I will not just believe the management - for example Pat Byrne of Overstock .com, who can print himself some more shares whenever he feels like it and sell them to us gullible suckers.

Look - there was clearly some evil mischief going on in the baning collapse - principally in CDS. Thats where some nasty conspiracy combined with naked shorting cut off access to funding for the banks. However it wasn't covered stock shorting. It was uncovered CDS. More generally market manipulation is a bad thing. That can happen in both long and short positions. Trust me shorts don't kill companies. Speculative conspiracies kill companies. Check out GSs behavour in oil futures just prior to the recent peak. Something very naughty might have happened. And not a short contract insight. All purchases of oil contracts till its victim was dead - and oil traded close to 150. And then the market just plummeted.

Thats my two cents worth. But hey dont trust me. Dont trust anyone. Get out there and verify!

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