Short Sell Shock

Brian Doherty | September 19, 2008

As someone who had been saying for the past few years that things like Nixonian wage and price controls would be considered beyond the pale in a world that, I thought, understood and appreciated some basics of free markets more than it did 35 years ago, well, it's a good thing my jaw has dropped so much on the past week's news that I have room to fit a lot of crow.

Well, my man Mises always said that some interventionism always created the impetus for more and more interventionism, and this month could be fruitfully dedicated to the old Austrian's memory.

It shouldn't have, I know, but the short-selling ban on financial stocks took me by surprise. An observation from Arnold Kling on this matter:

How can short-selling destroy a good company?

The simple answer is that it can't.

First of all, short-selling can't force down your share price. Short-selling only forces down your share price if buyers don't emerge to defend your share price.

Banning short-selling cannot protect a bad stock. If nobody is willing to buy XYZ at a price higher than $.02 a share, then the price at which XYZ will trade will be $.02 a share (or lower). It doesn't matter whether you have short-sellers or not.

What drives stock prices down is the lack of people willing to buy them at the higher price. If the company has sufficient value, there will be sufficient buyers.

Megan McArdle, while agreeing in theory, thinks Kling underestimates the potential dangers of short-sellers:

If short-sellers flood a market, they can overwhelm the buyers, especially when you have a massive credit contraction in the markets.

Stephen Bainbridge also has a good, thorough list of reasons why this ban is stupid and will be of no particular help in solving the problem of massive sky-high piles of bad debt.

Comments

Naga Sadow|9.19.08 @ 2:16PM|#

They banned short selling? Where the hell were the hedge funds? Don't a large percentage of their moves involve short selling? Isn't that why their are called "hedge" funds?

Derrick|9.19.08 @ 2:22PM|#

I've recently been shocked by how little the general public understands the most basic economic concepts, like how prices are affected by supply and demand. If they don't even grok that much, how are we supposed to get anywhere?

|9.19.08 @ 2:22PM|#

Short selling itself may not be able to force a price down, but rumors that a lot of people are shorting a stock may lead people to lose confidence in it.

Also, welcome back Brian Doherty. I haven't been around much the past couple of weeks, but you haven't been around for months.

|9.19.08 @ 2:30PM|#

The way to keep short sellers and prevent short sellers from flooding a market is simple. Bring back the uptick rule on short sellers. When I read that they got rid of it last year, I thought it was the most idiotic thing I'd heard.

Jay|9.19.08 @ 2:35PM|#

The problem is naked shorting, when firms sell shares that they haven't yet borrowed. This is an abusive practice that can hurt good firms.

My assumption about this is that the overall ban on short selling is just temporary until they can figure out how to prevent naked shorting.

Of course, naked shorting is illegal and the law should have been enforced all along.

JP|9.19.08 @ 2:37PM|#

Can someone explain why naked shorting is harmful? I don't get it. (Seriously, I don't.)

|9.19.08 @ 2:38PM|#

My 401(k) has been preventing short selling for quite some time. If you hold a security for less than a certain amount of time and want to sell it, you pay an additional 2% fee. This helps everyone that has the fund by cutting down on sales commissions.

Of course, if you can sell it and make up that 2% and then some, you should be probably working in the financial sector anyway.

|9.19.08 @ 2:40PM|#

My assumption about this is that the overall ban on short selling is just temporary until they can figure out how to prevent naked shorting.

Yeah, just like that "temporary" telecom tax that was supposed to fund the Spanish-American war or whatever.

Jay|9.19.08 @ 2:48PM|#

I'll bet short sales come back within a few weeks. The market really won't function without them.

The problem with naked shorting is that is is essentially an order to sell stock by a person who doesn't control the stock they're trying to sell.

Imagine if everybody in America listed a rare baseball card for sale on eBay at the same time, even though none of the sellers actually owned the item. The market price for that item would drop like a stone. If you do that to a company's stock, it might cause the company to go bankrupt.

|9.19.08 @ 2:49PM|#

First they come for the free markets, then they come for the free minds.

|9.19.08 @ 2:50PM|#

Drink!

I, Kahn O\'Clast|9.19.08 @ 2:51PM|#

Damn! Now I'm going to have resort on more traditional options like calls and puts to hedge my portfolio.

The real question is: can I still borrow shares and not sell them? If so, the I'll just borrow the shares, sell a call to finance and still make money when the stock falls.....

andy|9.19.08 @ 2:52PM|#

shorting stock is legit and keeps markets in line, but naked shorting does no such thing and artificially and illegally creates chaos.

naked shorting is the process by which a hedge fund short sells stock that it doesn't own, borrow or intend to obtain. this results in a number of "ftds" or "failure-to-delivers," which process 3 days after the short sale (quite a lag). for example, if a public company only has 100,000 shares in float, a hedge fund can fraudulently short 1 million shares despite the fact that it results in more than 100 percent of the company's stock being made available. this happens by opening up short sales in overseas markets where the public companies don't see this happening.

those of you with a basic understanding of inflation understand that when you have 100,000 shares of stock and those 100,000 shares quickly and incorrectly turn into 1 million shares, you've diluted shareholder value and stock price will drop like a stone. of course, these 1 million shares will be recorded three days later as "failure to delivers," but the damage to the company will be done already. oh... and guess what position the hedge funds will take on the companies they're naked shorting (hint: it's not long.) once that share price hits rock bottom, ding! profit!

seriously, i'm not saying we need to legislate this, i'm just saying we need to investigate fraud in the system and get the sunlight inside the dtcc (http://en.wikipedia.org/wiki/Dtcc).

|9.19.08 @ 2:54PM|#

sage wrote "My 401(k) has been preventing short selling for quite some time. If you hold a security for less than a certain amount of time and want to sell it, you pay an additional 2% fee. This helps everyone that has the fund by cutting down on sales commissions"

That isn't short selling.

Short selling is when you borrow some stock from a broker, then sell it, expecting that the price will drop.

When the price drops, you buy it again at the lower price, and give it back to the original lending broker.

You profit by keeping the difference between the price you sold at and the lower price you bought at.

|9.19.08 @ 2:54PM|#

In the old days, they would have just closed the markets for a few days.

Hopefully, that's all this is - a breather to stop people from acting in panic.

Mo, what's the uptick rule?

I. Kahn O\'Clast|9.19.08 @ 2:55PM|#

BTW there is little to no "naked" shorting: you borrow the stocks from someone who has them in order to short them and you pay a fee for the privldge.

|9.19.08 @ 2:55PM|#

sage | September 19, 2008, 2:50pm | #

Drink!

That was quick...glad I didn't have to wait long

Russ 2000|9.19.08 @ 3:00PM|#

That's the funny part of the whole week. The government is trying to increase liquidity with one hand and decrease liquidity with the other. We have so many regulators we effectively have no regulation (but lotsa transaction costs).

|9.19.08 @ 3:01PM|#

Jon H, thanks for the clarification. In my case it is indeed shares that I own. Not ones that I borrow.

Will these rules put day traders out of business? I know that they became quite prolific during the dot-com boom.

|9.19.08 @ 3:02PM|#

I've recently been shocked by how little the general public people running our financial institutions understands the most basic economic concepts, like how prices are affected by supply and demand. If they don't even grok that much, how are we supposed to get anywhere?

fixed?

Kolohe|9.19.08 @ 3:03PM|#

The other problem with "Cox's List" is that now those not on it are lobbying to get on it (like GE). And it was done in such a rush that there are typos which misidentify the targeted companies. They're trying to be too cute buy half by making the list large enough so it doesn't look like their creating a s*** list.

If they were going to do this, it should have been an all or nothing afair.

Invisible Finger|9.19.08 @ 3:04PM|#

Imagine if everybody in America listed a rare baseball card for sale on eBay at the same time, even though none of the sellers actually owned the item. The market price for that item would drop like a stone.

The actual market price is only known when the transaction clears. Until then it's merely bid and ask prices.

Brandybuck|9.19.08 @ 3:06PM|#

Megan McArdle, while agreeing in theory, thinks Kling underestimates the potential dangers of short-sellers...

Oh noes! Unfettered capitalism will kill us all! We needs gummit to save us!

p.s. I've heard people refer to Ms. McArdle as "libertarian". I should take up drinking.

|9.19.08 @ 3:08PM|#

Mo, what's the uptick rule?

!?!?!? HA HA HA HA
That's classic joe. Tell us again how your understanding about economics is superior to ours.

Kolohe|9.19.08 @ 3:09PM|#

Mo, what's the uptick rule?

The uptick rule is (IIRC) that once you can only do a short sale after the market price (bid or ask I'm not sure) goes up by a certain amount. (back in the pre decimal days, I think it was 1/8)

robc|9.19.08 @ 3:10PM|#

joe,

Im sure I get some details wrong, but the uptick rule only allowed you to short a stock on a price uptick.

Fluffy|9.19.08 @ 3:12PM|#

The uptick rule was an exchange rule that said that a short sale could only be made at a price above the last traded price.

This would prevent a short from reading the open order book, and simply hitting the sell button until he cleared orders down to a price he wanted the stock to hit.

Kolohe|9.19.08 @ 3:12PM|#

It's kind of a dick move to call someone out for not knowing something.

It's also kinda lazy not use the Google :).

|9.19.08 @ 3:13PM|#

Tell us again how your understanding about economics is superior to ours.

OK, Warren. I actually find out facts before offering an opinion, rather than basing everything on my feelings.

That's why my understanding is superior to yours, anyway.

robc|9.19.08 @ 3:14PM|#

I agree with Kolohe 100%.

Come on joe, I even verified with google before I hit submit so I wouldnt get the rule backwards.

JP|9.19.08 @ 3:14PM|#

Jay and Andy -- A couple follow-up questions.

1. If naked shorting drives down the price by creating tons of fake offers to sell, doesn't the price return to equilibrium after the failures-to-deliver come through? And aren't financial players able to see past such fluctuations?

2. Also, how does driving down the stock price bankrupt a company? It may trigger covenants on the company's borrowing, but the company and its lenders should be able to work that out if the effect is short-lived (see question 1).

|9.19.08 @ 3:14PM|#

Warren has been utterly unable to even offer a counterargument to anything I've written in the past week on this subject.

But he got to catch me not knowing a term.

Boo yah! In your face, joe! Pwned!!

Juvenile asshole.

|9.19.08 @ 3:21PM|#

The uptick rule is (IIRC) that once you can only do a short sale after the market price (bid or ask I'm not sure) goes up by a certain amount. (back in the pre decimal days, I think it was 1/8)

...

Im sure I get some details wrong, but the uptick rule only allowed you to short a stock on a price uptick

Close, but not quite. The uptick rule was that you could not short sell a stock unless the last directional move was up. So if a series of trades was:

1.01 1.02 1.01 1.01 1.01

You could not short sell on the next trade because the last directional move was down (1.02 -> 1.01).

If it looked like:

1.02 1.01 1.01 1.02 1.02

You could short sell on the next trade because the last directional move was up (1.01 -> 1.02) even though the last trade was neutral (1.02 -> 1.02). The no price change trades don't count. The magnitude of the change is irrelevant.

The advantage of this was that short sellers couldn't run the price down and flood the market with short orders. This prevents the situation McMegan describes.

|9.19.08 @ 3:21PM|#

If shorts are outlawed, only outlaws will have shorts?

|9.19.08 @ 3:23PM|#

Oh and I forgot, as Fluffy reminded me. You could get around this by shorting above the current market price.

In joe's defense, Warren, it's a relatively obscure rule for those not in the business. The only reason I know it is because I used to be a trader.

|9.19.08 @ 3:24PM|#

Damn! Now I'm going to have resort on more traditional options like calls and puts to hedge my portfolio.

I am not expert, but I think there won't be anyone *selling* puts, if they're not allowed to short stock to hedge their positions.

|9.19.08 @ 3:24PM|#

Juvenile asshole.

Ouch. Wait here while I think up a suitable retort.

No Name Guy|9.19.08 @ 3:27PM|#

So, on those failure to delivers....sounds like there's a contractural issue here.

Hold the naked shorts feet to the fire and MAKE them deliver what they promised (eg the shares they nakedly shorted). Then they have to go in and cover their short, and amazing..... I shorted 100 shares yesterday, now I have to cover by buying 100 shares today. Simple enforecement of the contract (to deliver the shorted shares) is sufficient to ensure overall balance.

Duh...... How many times have we all heard of a 'short covering rally'.

|9.19.08 @ 3:29PM|#

If the feds really wanted to make a difference they should outlaw selling altogether and allow only buys. The market would really do well then. :)

robc|9.19.08 @ 3:29PM|#

Mo,

In joe's defense, Warren, it's a relatively obscure rule for those not in the business. The only reason I know it is because I used to be a trader.

I have to disagree. I have never shorted a stock and I knew about the rule and Im not even remotely in the business. My Dad explained the rule to me back in the 80s.

|9.19.08 @ 3:33PM|#

I think I've proved my bona fides in the "knows obscure crap" department well enough to just eat this one.

|9.19.08 @ 3:35PM|#

Re: Naked shorts:

Up until recently, the SEC has been insisting that naked shorts aren't a problem. From wikipedia:

Regulators downplay the extent of naked shorting in the US. At a North American Securities Administrators Association (NASAA) conference on naked short selling in November 2005, an official of the New York Stock Exchange stated that NYSE had found no evidence of widespread naked short selling, and alleged "fear mongering that there's this rampant naked shorting that's gone unregulated."[citation needed] Cameron Funkhouser, NASD senior vice president of market regulations, noted that although companies have alleged stock manipulation through the Berlin stock exchange, the NASD has seen not one instance of naked short selling [on the Berlin stock exchange]". An official of the SEC said that "While there may be instances of abusive short selling, 99% of all trades in dollar value settle on time without incident."[7] Of all those that do not, 85% are resolved within 10 business days and 90% within 20.[7]

The SEC's short selling FAQ also cites common misconceptions about the practice, such as the belief that naked shorting causes "phantom" shares to enter the market, as one source of confusion over the practice's market effect. Naked short selling, the SEC said, would not increase a company's shares outstanding shares nor result in "counterfeit shares."[2] Short seller David Rocker contended that failure to deliver securities "can be done for manipulative purposes to create the impression that the stock is a tight borrow." In such a situation, the failure to deliver would be on the part of "longs," not "shorts."

Statistics on failures to deliver securities are sometimes used as evidence of naked short selling in specific stocks. However, the U.S. Securities and Exchange Commission stated in January 2008 that "fails-to-deliver can occur for a number of reasons on both long and short sales. Therefore, fails-to-deliver are not necessarily the result of short selling, and are not evidence of abusive short selling or 'naked' short selling."

I, Kahn O\'Clast|9.19.08 @ 3:39PM|#

ChicagoTom,

Call and Put contracts do not require the buying, selling or borrowing of the underlying security. Most are settled for cash without any trade in the referenced stock or bond.

|9.19.08 @ 3:43PM|#

In joe's defense, Warren, it's a relatively obscure rule for those not in the business. The only reason I know it is because I used to be a trader.

Understood. But weigh that against joe's comments on any of the taxes, regulation, eminent domain, social security, health care, etc. threads. It's like if LoanWacko didn't know what a H-1B was

Paul|9.19.08 @ 3:45PM|#

Don't even get me started on this one. Jesus H. Christ. Price, it's not what you say it is, it's what the market will bear.

A crazed, grenade lobbing biker with a Roadrunner tattoo on his arm understood that.

|9.19.08 @ 3:47PM|#

It's like if LoanWacko didn't know what a H-1B was

LoanWacko???
Freudian slip? Or joe's law?

|9.19.08 @ 3:48PM|#

How, exactly, is the definition of the uptick rule relevent to eminent domain, taxes, regulation, social security, or health care?

Brandybuck|9.19.08 @ 3:49PM|#

Isn't there a pr0n site called www.nakedshorts.com? Let me check right now... nope. Time for someone to make one!

Mike Laursen|9.19.08 @ 3:53PM|#

Can someone explain why naked shorting is harmful? I don't get it. (Seriously, I don't.)

I suppose it could be, but in actual practice it's not that common and didn't have anything to do with the current financial sector meltdown. It's just being used as a scapegoat to make it look like the government is taking action.

Mike Laursen|9.19.08 @ 3:54PM|#

Like the whole oil speculators scapegoat.

robc|9.19.08 @ 3:57PM|#

joe,

How, exactly, is the definition of the uptick rule relevent to eminent domain, taxes, regulation, social security, or health care?

Think about it this way, I like watching Good Eats, Alton Brown has taught me a lot about cooking. As has come up before, I know a lot about homebrewing. His episode on homebrewing makes a number of newbie type mistakes and he misuses some terminology. So, it makes me wonder if he is making the same kind of mistakes when discussing stuff I know nothing about.

For another example, see Bill James's "review" of Halberstam's Summer of '51. In it, James asks if Halberstam is as shoddy in his research of political books as he is in baseball books. A reasonable question, dont you think?

Follow the pattern?

robc|9.19.08 @ 3:58PM|#

argh, end the italics after "51".

My knowledge of financial markets is greater than my html tagging ability.

|9.19.08 @ 4:03PM|#

Sounds like a chain of thought that would appeal to somebody who's read an argument he doesn't like but can't refute.

robc|9.19.08 @ 4:06PM|#

joe,

Despite my 3:57 post, I dont get Warren on this. Asking about the uptick rule isnt a big deal, at least you didnt like to play it off like you knew what it was. You should have googled instead of asking, but thats no biggy.

The uptick rule is the kind of regulation I can accept. Doesnt prevent shorting, but prevents some game playing. Banning shorts (even in just one sector) is a stupid regulation, on the other hand.

|9.19.08 @ 4:12PM|#

Short selling is also being used as part of market manipulation schemes (reverse pump-and-dump).
Sell a company's stock short, spread bad rumors (often of dubious veracity), and buy to cover after the market drops.
It is much harder to deal with these than with the classic pump-and-dumps, but it's still closely akin to fraud.

DannyK|9.19.08 @ 4:15PM|#

IMPERIAL DECREE #25,251,332

In order to protect the vitally important clothing industry, anyone who says the Emperor is naked WILL BE SHOT.

|9.19.08 @ 4:15PM|#

Asking about the uptick rule isn't a big deal

Very well, I retract my laughter and derision directed a joe.

But you know what is a very big deal? All day long none of us land lubbers have participated in International Talk Like A Pirate Day. Arrrgh, ye be a sad lot of swabbies.

robc|9.19.08 @ 4:17PM|#

Warren,

Oh crap, its 9/19 isnt it.

I mean, arrrrrrg, it be the 19th of September, matey! Avast. Yo ho ho, lets drink some Rum.

DannyK|9.19.08 @ 4:18PM|#

On a less humorous note, there was an episode of This American Life about this very subject just this weekend, you can probably still listen to it or podcast it for free from their website. They interviewed some previous SEC types, who concluded that naked short selling wasn't that big a deal.

Happy Jack|9.19.08 @ 4:27PM|#

In joe's defense, Warren, it's a relatively obscure rule for those not in the business. The only reason I know it is because I used to be a trader.

Were you around for the Iomega short squeeze?

|9.19.08 @ 4:35PM|#

DannyK,
That episode is like a month old. It's the very best thing I've heard or read on the subject. I have to say, my favorite part was:

Adam Davidson: You might not believe me, but that little statement: that is Central
Banker speak for "Hey, global pool of money - screw you."

Alex Blumberg: Come on, that's not what he said

Adam Davidson: It is! I speak central banker and that's what he's saying.

mike|9.19.08 @ 4:35PM|#

When there are no constraints on short sellling buyers will be far less willing to put a bid in - why step infront of a freight train?

Second - short sales happend in many ways - directly, as a pass through by shorting an ETF, and by inverse total return swaps. The latter are used by 'long' 2x short funds such as SKF. The seller of the swap will hedge by shorting, but they are usually a large financial institution which has the shares as custodian for other clients.

|9.19.08 @ 4:37PM|#

Were you around for the Iomega short squeeze?

If by around, you mean alive. Then yes.

If by around, you mean around by following the markets? Then no. I was in my victory lap senior year of high school getting ready to move cross-country.

If I remember my history, this was in 96, correct?

|9.19.08 @ 4:44PM|#

For another example, see Bill James's "review" of Halberstam's Summer of '51. In it, James asks if Halberstam is as shoddy in his research of political books as he is in baseball books.

Good point robc. However, this would be true if joe spoke ex rectum about short selling and said something like how Clinton enacting a short selling rule was brilliant. Here, he acknowledged his ignorance (and that he's too lazy to Google). I respect when people acknowledge their lack of knowledge and ask questions.

Happy Jack|9.19.08 @ 5:03PM|#

If I remember my history, this was in 96, correct?

Yes. It pointed to the danger of the Yahoo message boards.

I'm assuming they taught you about that.

Doug|9.19.08 @ 5:10PM|#

If shorts are outlawed, only outlaws will have shorts?

Could be. For the time being, though, they're just suspending them so I have to wonder if shorts are suspended, will only suspenders have shorts.

Ben|9.19.08 @ 5:23PM|#

What Is "The Economy"?

Its very easy look at who is screaming the loudest that the government must do something. These are the people that have been benefiting from the distorted and over valued assets that are starting to unwind. They know that the gig is up. The profits taken over the past decade on Wall Street by hedge funds and the like are not real they are a bubble filled with nothing but hot air. They were not producing anything of real value or at least not of the value they were claiming. So, what do they do now?

http://digg.com/political_opinion/What_is_The_Economy

|9.19.08 @ 5:35PM|#

Its very easy look at who is screaming the loudest that the government must do something. These are the people that have been benefiting from the distorted and over valued assets that are starting to unwind.

John Cole had this to say and I think he said it rather well:

... folks spent years making billions upon billions of dollars on risky transactions, more money on the stock of companies that was artificially high based on those transactions, more money bundling all those transactions into more transactions, and made a killing, and when it turns out the whole thing is a big pile of shit, you and I get the god damned bill.

I do not ever want to hear another damned word about the free market. I don't want to hear another thing about letting the market regulate itself. I don't want to hear about the free flow of capital. I don't want to hear about government getting out of our lives.

None of it. From superfunds to super-bailouts, I am tired of other people getting rich being irresponsible and then being told I have to pay to clean it up. I didn't read one punitive aspect of this new plan. Not one punishment for the people who did this.

GILMORE|9.19.08 @ 6:53PM|#

naked shorting is the process by which a hedge fund short sells stock that it doesn't own, borrow or intend to obtain. this results in a number of "ftds" or "failure-to-delivers," which process 3 days after the short sale (quite a lag)

Actually, 3 day delivery is considered "regular way" settlement for any security.

e.g. http://www.answers.com/topic/regular-way-delivery-and-settlement

also, any individual investor with a registered short account can borrow and short stocks. That person would not physically have to own the underlying instrument, but rather his brokerage account would simply ensure that the stock remains in either their or a counterparties inventory, and charge a slight fee to the investor to 'hold' them in name.

How many people here have ever taken the Series 7?

I, Kahn O'Clast | September 19, 2008, 2:51pm | #

re: borrowing and selling calls

Your idea works except the price of the calls at strike you want and the price of borrowing would (in theory) fluctuate against one another such that making money this way would yield way less than a straight covered short.

Arnold Kling's comment above is pretty much spot-on, and the demonization of short-selling has been a popular myth ever since the depression. joe still talks about "speculators" in turn-of-the-century terms...as though people are printing and marketing worthless paper.

that definition is closer to the fed.

Anyone notice the recent t-bill yield?

andy|9.19.08 @ 6:58PM|#

chicagotom:

it's interesting that you site a wikipedia article on naked short selling and, in particular, quotes from david rocker. why?

http://www.deepcapture.com/a-bad-day-for-criminals-and-the-journalists-who-love-them/

http://www.deepcapture.com/5000-words-about-an-obscure-bad-newswire-reporter/

just a couple of the posts on david rocker... the gist of this guy's lack of credibility:

"In a lawsuit filed in 2006, Fairfax claimed that this group of short sellers - Steve Cohen, David Rocker, Jim Chanos and Dan Loeb - conspired with Morgan Keegan to manufacture false, negative research about Fairfax."

not to mention, an ENTIRE CITY in utah was not allowed to edit wikipedia because of overstock's attempts to reveal evidence of naked shorting on the page devoted to it. wikipedia covered this up, not-so-subtly:

http://www.deepcapture.com/the-tale-of-slimvirgin/

http://www.deepcapture.com/the-final-word-on-gary-weiss-and-wikipedia/

and basically all of www.antisocialmedia.net

this crime goes deep (hence "deep capture") and none of these guys would allow a message board and especially not something as widely accessible and viewed as a wikipedia page to tell a story different than their own.

i hope, instead of writing off me and the deep capture pages, that the writers, editors and readers of reason will actually take a look at what they have to say and see how well documented it is. hell, bloomberg even covered the issue:

http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vIrfhgQPAJ1s.asf

and to jp:

it might be a "short-lived event," but so is a 9.0 earthquake. lots of things don't hold up through crumbling stock: they lose their ability to get credit (see: when a reporter falsely claims that bear stearns line of credit from goldman is cut shortly before bear stearns collapse, source: http://www.deepcapture.com/did-a-cnbc-reporter-help-destroy-bear-stearns/) and are seen as horribly mismanaged and can't recoup. mismanagement might be true in some cases, but as you'll see in the bloomberg video, a lot of the companies targeted and victimized by naked short sellers are otherwise well-managed.

andy|9.19.08 @ 7:03PM|#

gilmore:

you don't even need a high school diploma to get series 7 certification; just a sponsor. i have a bachelor's in finance.

yes, anyone can short stock, but not anyone can open another company's stock on a foreign exchange and create and float millions of shares that the company didn't authorize... no, only hedge funds have the capital and the ability to make this happen. explained in three ways here:

http://www.deepcapture.com/category/4-the-crime-naked-shorts-other-insincere-ious/

Paul|9.19.08 @ 7:05PM|#

If short-sellers flood a market, they can overwhelm the buyers, especially when you have a massive credit contraction in the markets.

Aaaaannnndddd?

Paul|9.19.08 @ 7:07PM|#

I'll bet short sales come back within a few weeks. The market really won't function without them.

Waaaaiiit a second!!! I thought the market wasn't functioning with them?

|9.19.08 @ 7:17PM|#

joe | September 19, 2008, 3:14pm | #

Juvenile asshole.

And you kids get off my lawn!

BakedPenguin|9.19.08 @ 8:00PM|#

Aaaaannnndddd?

If short sellers are selling borrowed stock, no problem. The problem with naked shorting, as mentioned above, is that (potentially) >100% of the float could be shorted. Of course, a company's stock price would crash long before its entire float had cycled.

This has negative implications for a company's financial situation, since the terms of bank borrowings and bond offerings often hinge (to some extent) on stock price.

johnl|9.19.08 @ 8:25PM|#

Naked short selling is a myth pushed by promoters of investment scams Publicly traded perpetual motion machine scams, promoters of mines that are known duds, investment companies whose assets consist of bonds in bankrupt companies bought from antique dealers and such want their investors to believe that there is an are mysterious illegal conspiracy to hold their companies back. There is no sure fire way to make money, period.

Deepcapture was created by Overstock.com employees and originally hosted on Overstock servers.

|9.19.08 @ 11:21PM|#

"But you know what is a very big deal? All day long none of us land lubbers have participated in International Talk Like A Pirate Day."

That's because after all the bailouts and all the debt we're taking on, from now on it's going to be "Talk Like An Emirate Day", because they'll own our sorry asses.

Famous Mortimer|9.19.08 @ 11:23PM|#

"I have to disagree. I have never shorted a stock and I knew about the rule and Im not even remotely in the business. My Dad explained the rule to me back in the 80s."

So, you're father happened to discuss the term with you, which somehow proves your point about it being something that should be automatically known in finance debate? I guess Joe's father fucked up by withholding this important tid-bit from him.

Joe's public enemy #1 around here because he challenges the Libertarian status quo, and frustrates the "community."

Usually, when people feel threatened by others in an argument, they will revert to picking on trivial issues such as spelling, typos, or the occasional lapse in knowledge regarding every single vocabulary term relevant to a subject.

It's a lazy way to try and score points, and it should not come from anyone who has a real interest in serious discussion.

GILMORE|9.19.08 @ 11:27PM|#

andy | September 19, 2008, 7:03pm | #

gilmore:

you don't even need a high school diploma to get series 7 certification; just a sponsor. i have a bachelor's in finance.

Whoop de do. It still points out that you were misleading about a) who and how people sell short, and b) that the resolution of trades was somehow unusual. If you worked in finance you'd have to know this. (i.e. my ref to basic certification as a registered rep)

Do you?

Pumping and dumping is nothing new and neither is rumor mongering or self dealing by hedge funds or any other type of investment house. Your blog link is a 911-truther version of financial dealings. The financial collapse going on, like most things, is more simply explained by incompetence and hubris than it is malice or conspiracy. And Americans having a negative savings rate, among many other things.

|9.19.08 @ 11:29PM|#

"Up until recently, the SEC has been insisting that naked shorts aren't a problem."

Confidence in government regulators? Here?

GILMORE|9.19.08 @ 11:40PM|#

BakedPenguin | September 19, 2008, 8:00pm | #

Aaaaannnndddd?

If short sellers are selling borrowed stock, no problem. The problem with naked shorting, as mentioned above, is that (potentially) >100% of the float could be shorted. Of course, a company's stock price would crash long before its entire float had cycled.

This is untrue, and misunderstands how borrowed stock gets shorted.

Owners/primary dealers/market makers of a stock may lend a portion of holdings to be shorted, but do so at fee. The more stock held short ("short interest") the higher the fees, such that there is always a) a limit to the total holdings available to short, and b) a limit to the net gain after costs, such that shorting an obvious downside risk costs more than shorting something felt to be on solid ground.

In some cases, companies cant be simply shorted out of existence because the % of float outstanding to be shorted is just too small. A few large investors may hold 70%, and potential short holds can only ever hit as much as 10% of the stock at a time.

Pick a stock and plug it in here to see what kind of short interest is outstanding - Citigroup as an expample

http://shortsqueeze.com/?symbol=C&submit=Short+Quote%99

Mike Laursen|9.20.08 @ 12:17AM|#

Joe's public enemy #1 around here because he challenges the Libertarian status quo, and frustrates the "community."

Huh? joe's not public enemy #1. We kinda like him. #1 would be Lonewacko.

johnl|9.20.08 @ 1:09AM|#

Can we lay off joe for a minute? The naked short sale myth pushers are where the attention belongs.

johl|9.20.08 @ 2:03AM|#

joe I believe you were asking what's the argument that the mortgage crisis and its severity is the FED's fault.

Quick answer is that Greenspan inflationary policies caused a flattening and even an inversion of the yield curve in 2004-2005. This is always bad news. Usually people who have to invest with long time horizons, like pension plans, can buy long bonds to beat short term yields. But not in an inversion/flattening. So people who needed to beat the short term zero risk rate had to take on more risk. Most of the risk premium paying bonds issued those days were backed by cashout refies to folks who wanted to use paper appreciation on their overvalued homes to bail themselves out of their last cashout refies ...

Also Greenspan was talking up realestate as a safe investment. Remember?
"""There is no national housing market in the United States. Local conditions dominate, even though mortgage interest rates are similar throughout the country. Home prices in Portland, Maine, do not arbitrage those in Portland, Ore. Thus, any bubbles that might occur would tend to be local, not national, in scope."""

Right, no national market for houses, but a national market for MBSs. Scary to think he might have believed what he was saying.

VM|9.20.08 @ 11:03AM|#

warren - knowledge of finance terms isn't a gauge of knowledge of economics.

had the question been something like "what's walras's law" (grin), then you coulda gone there :)

andy|9.20.08 @ 6:51PM|#

comparing naked shorting to 9/11 truth is a lazy analogy to write off people concerned about large-scale fraud. i have no idea why i responded to you in the first place, gilmore. i was not pointing out that "three days" is unusual to process, just saying that three days is a good amount of time for some damage to be done before corrections are made.

would you disagree that 3 days is a lot of time in the market? how many days did it take for bear stearns to collapse? 2 days? and is overstock wrong in saying that a cnbc reporter made anonymously sourced claims that bear stearns lost its credit line (despite have $16 billion in cash for leverage)? if you can point out how and where deepcapture is telling lies, i'd be interested to know. if you and johnl (who seems to think that overstock.com is in the perpetual motion machine business... i always thought they had actual products to sell and were a successful company, oh, and another, even-more-lazy connection) just want to say, "don't listen to the naked short seller conspirators, they're crazy," you're just being dismissive.

but never expect a man to understand what you're saying when his livelihood is dependent on NOT understanding it. i worked for a large securities brokerage doing alternative investments then realized that i hated it and didn't go on to the series 7. do you work for a hedge fund? so you know how it works when hedge funds short stock? you know what rules apply to them and when they bend them? you know that they can't borrow more than is being floated? (well, they clearly can't REALLY borrow more than is being floated, but they can fabricate it and pass it off as real, is what i'm getting at.)

johnl|9.20.08 @ 11:04PM|#

No Andy, Overstock is not a successful company. In their entire history, they have had only two profitable quarters, They have no hope of becoming profitable, so they invest a lot in lobbying, special pleading, junk lawsuits and such, in an effort to get the stock to appreciate in the absence of profit. And, yes, this is a libertarian site, so we are dismissive of rent seeking special pleaders like the naked short sales conspiracy theorists.

GILMORE|9.21.08 @ 12:25AM|#

plus you sound like an idiot

johnl|9.21.08 @ 1:41AM|#

Gilmore scam victims are hard to like. They are constantly harping on how whatever scam they got taken in was really a good investment, and they really would have made a lot of money, if it wasn't for some bad guys. The bad guys are never the crooks with their money but the CIA, the energy companies, short sellers, and other usual suspects. They are often very reluctant to provide information about the crooks who robbed them. And yeah, they sound like idiots.

Try to remember is that crooks who specialize in fraud in broad daylight know that too and use it to their advantage. By, like, getting them to organize politically to change regulations to make fraud easier.

Kevind Delaney|9.21.08 @ 3:37AM|#

I am not surprised that the public has little knowledge of shorts. I am really surprised that libertarians have so little knowledge of property rights, and that so many libertarian rags support the coersive practice of short selling.

Short selling involves selling property that does not belong to you.

Short selling is the creation of a regulatory regime. A property owner would not willingly allow someone to sell a claim on their property without some form of coercion.

Shorting directly hurts property owners by increasing the float of stock against their company and effectively decreasing the market value of their firm. A company that would have a market value with a PE of 10 with minimal shorting would only get a PE of 8 in a market with heavy shorting.

A decade ago short positions were relatively small, and most people held shorts for a short duration. In the last decade we've seen a dramatic change in the way that the market views shorts. Hedgefunds, and other large investors, are taking out short positions equal 30% or more of their portfolio. In our new market, we see that even healthy companies have 30% of their stock held short.

We can see the result of this state change in the large number of firms that are pulling their stock off the market and the dry up of IPOs as developing companies no longer see selling stock on the open market as a viable funding mechanism.

Instead of asking the question: Should shorts be regulated? Ask the question: Would a property owner allow a third party to short his home? Would Ayn Rand allow a secondary publisher to short "Atlas Shrugged." Imagine if a person sold 10k pirated copies of the book when it was released, then legalling up a few years later by buying used copies of the book a few years later.

I would think the Libertarian view would be that shorting is a taking created by a coercive market. Property owners would only allow the taking when coerced by the regulators of the market.

I am really surprised that libertarians are screaming about the coercion that is involved in a market that allows shorting of stock.

|9.21.08 @ 10:13AM|#

"Megan McArdle, while agreeing in theory, thinks Kling underestimates the potential dangers of short-sellers"


No, you've quoted her not only NOT agreeing in theory, but demonstrating she has found another topic she knows nothing about.

johnl|9.21.08 @ 12:50PM|#

Kevind, Rand shorted her own books. There is no coercion to short selling. Shareholders are not forced to lend out their shares. And the companies that ask their shareholders not to lend out their shares are always junk.

Kevin Delaney|9.22.08 @ 4:35AM|#

johnl,

Did I say the shareholder lending their stock was coerced?

The definition that there is no coercion if you can find a willing party in a scheme seems a bit absurd.

The guy pointing the gun at the teller is doing so of his free will; therefore a bank robbery is not coercion.

According this view, a dictator who willfully loots from the people is not coercive because the dictator is looting willfully.

I suspect one could find a willful participant in any action every labeled "coercive." If your definition is that an act is not coercive if you can find anyone willfully engaging in the act; then I would say no act is coercive.

In the case of shorts, everyone but the rent-seeking shareholder and the shorter suffer from the short by an increase in the float of the stock which effectively devalues the stock.

The coercion comes because a regulatory regime demands that, for a company to trade shares on the open market, they must allow the shorting of the stock.

Shorting is a creation of a regulatory regime.

Historically, most investors considered the taking nominal ... one might see it as a tax that brokerage houses collect as part of the trade. In recent years, the takings related to short selling have become substantial as hedgefunds and certain private investors develop strategies with substantial short positions.

BTW, there is a whole slew of coercive schemes designed to concentrate benefits on a few and costs on the many. Those who receive the benefits almost always accept the benefits willingly.