Snake Oil Economics

Why Jon Stewart and Jim Cramer are both wrong about short-selling


"Look, we are both snake oil salesmen to a certain extent, but we do label the show as snake oil here. Isn't there a problem with selling snake oil and labeling it as vitamin tonic."

So spoke Jon Stewart during The Daily Show's recent "Brawl Street" segment, where Mad Money host Jim Cramer appeared to settle his high-profile feud with Stewart and came away, according to a general consensus, with his proverbial tail between his legs.

Stewart hammered Cramer and CNBC for taking so long to report the warning signs of impending financial disaster. For his part, Cramer begged for mercy and promised to be more of an advocate for small investors against Wall Street. "Absolutely, we could do better," he apologized, claiming he was shocked that "a lot of CEOs lied to me on the show…. I want kangaroo courts for these guys."

At the end, Stewart convinced Cramer to agree to a "deal" where, in Stewart's terms, CNBC gets "back to fundamentals on reporting…and I can go back to making fart noises and funny faces."

Yet for all of the kudos Stewart received for holding Cramer's feet to the fire, Stewart actually enabled Cramer to sell Daily Show viewers another type of economic snake oil: The false notion that short-sellers are a major cause of market downturns and should be severely restricted. "I have been trying to rein in short-selling, trying to expose what really happens," Cramer told Stewart. Curtailing short-selling, Cramer continued, "would cut down a lot of the games that you are talking about."

Short-selling figured prominently in the segment due to Stewart's airing of a 2006 interview Cramer did with The, where he recalled his past exploits as a hedge fund manager. In that interview, the hard-edged Cramer spoke with a sort of cynical bravado about sophisticated hedge fund strategies. It was a night-and-day contrast to the sunny television personality shouting "Buy! Buy! Buy!"

More notably, Cramer bragged about engaging in the very short-selling he now decries. He said he was often "position short" at his hedge fund, claiming "it is a very quick way to make money and very satisfying." He also said it was "very important to spread the rumor" and get out bad news about the company one is shorting.

Stewart was at once impressed and disgusted by this side of Cramer: "The gentleman on that video is a sober, rational individual. And the gentleman on Mad Money is throwing plastic cows through his legs and shouting, 'Sell! Sell! Sell!'… I can't reconcile the brilliance and knowledge you have of the intricacies of the market with the crazy bullshit you do every night."

Stewart then lectured Cramer indignantly about the insidiousness of those shorting strategies: "When I watch that, I can't tell you how angry I get…. You can draw a straight line form those shenanigans to the stuff that was being pulled at Bear and AIG and all this derivative market stuff that is this weird Wall Street side bet." He emphasized to his guest, "I want the Jim Cramer on CNBC to protect me from that Jim Cramer."

Yet it is precisely "that Jim Cramer"—and others who go against the grain by short-selling—who Stewart should be celebrating if he wants to deflate future bubbles. In the recent real estate run-up, the main problem with shorting and other "side bets" is that there weren't enough of them.

One of the most common forms of short-selling is borrowing shares from a broker, buying them back when the price drops, and pocketing the profits. There's a great risk of failure involved, of course, but short-sellers also send very important market signals about both individual companies and the economy as a whole. Most economists—both liberal and conservative—have seen shorts as a valuable counterweight to the market euphoria that creates bubbles.

As New Yorker business writer James Surowiecki observes in The Wisdom of Crowds, if the price of a stock "represents a weighted average of investors' judgments, it's more likely to be accurate if those investors aren't all cut from the same cloth." And as John Tamny, economist and editor of RealClearMarkets, writes in Forbes, "Short-sellers provide information, or what some call "feedback," to investors, (and) when their activities are made illegal, information that is necessary to correctly price securities is lost."

Indeed, in the mortgage bubble, short-sellers provided some of the earliest warnings about flaws in mortgage lending, securitization models, and the credit ratings process. According to The New York Times, William Ackman—who heads the hedge fund Pershing Square Capital Management and made a fortune shorting companies involved in subprime lending—publicly spelled out such risks as early as 2002. "What I said at the time to regulators and anyone who would listen is that this is a problem now, but it's going to be a bigger problem later," Ackman recalled in 2007.

Do short-sellers spread bad news, including rumors, about the companies they target in hopes of driving the stock price down, as Cramer described in his 2006 interview? Yes. But this bad news is exactly what Stewart and other commentators say should have been reported more often during the mortgage boom. Does it really matter if the information comes from parties who gain from it, so long as it balances the euphoria about "the next big thing"?

Unfortunately, Cramer seems to have influenced Stewart and his writers to spend more time bashing shorts. On a Daily Show episode a few days after the Stewart-Cramer confrontation, correspondent Samantha Bee lampooned the supposed evils of short-selling. Her segment featured a CEO who likened short-sellers to people who take out fire insurance on certain buildings and then burn them.

But in the mortgage bubble as in others, it was the companies themselves (aided and abetted by "pro-housing" government-created institutions such as Fannie Mae and Freddie Mac) that did the "burning" through their foolish practices. Short-sellers simply noticed the fire, spread the word, and profited from it.

Thanks to outdated restrictions on shorting for common investment vehicles such as mutual funds (compared to hedge funds that rely on an exemption for wealthy "accredited investors" that allows greater risk), however, middle-class investors were unable to enjoy many of the benefits of short-selling.

So rather than reining in hedge funds, lawmakers should liberate mutual funds from short-selling restrictions, which will produce both direct benefits for ordinary pension holders and the indirect benefit of having more shorts available to pop bubbles before they get too big.

Before Jon Stewart goes "back to making fart noises and funny faces," he should set the record straight on short-selling. Otherwise, Jim Cramer will have won and the joke will be on the American economy.

John Berlau is director for the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute and blogs at

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  1. Cramer might be the biggest phoney baloney mega douche on wall street. and that is saying quite a bit.

  2. I took this a different way completely. The way I saw it, Jon Stewart had a problem with Jim Cramer speaking of the ills of market manipulation to him on the show, when he specifically endorsed it on The Street interview. From what I remember, Jon Stewart never said anything against short selling specifically. It just happened to be a part of catching Cramer in the act of lying...blatantly.

  3. Cramer could have perfectly debated Stewart regarding his financial advise - which was crappy, of course, but nonetheless, Stewart know a lot less about finance and economics than the average cat (I mean, for crying out loud - he's an Il Duce supporter!)

    Stewart's show was a great piece of comedy and news reporting when he was bashing the Bush administration. He did a very balanced interview of Ron Paul. Now that his horse won the race (Il Duce), he is becoming as boring as watching flies make love.

    (Look, I just don't want to call Il Duce: "Idi", because that would just be too much.)

  4. I just don't want to call Il Duce: "Idi", because that would just be too much.

    How about "Oberammergau"? It has a nice little hint of Hitlerism that only the cognoscenti will recognize.

  5. I am afraid it will come down to an "Obamadamerung".

  6. Sorry, Obamadanerung.

  7. "Sorry, Obamadanerung."

    I typed "Obamadanerung" in Google and it asked -- Did you mean: Obama Dancing?

  8. Cramer is not and has never been against short selling. The main thing he wants to do is reinstate the uptick rule.

    Short-sellers simply noticed the fire, spread the word, and profited from it.

    There were several others (including Cramer himself) that simply said there was a fire without seeing any flames nor even smoke. This is the sort of that Cramer wants to rein as well. (yes, this is paris hilton extolling the virtues of chasity. It doesn't mean that he doesn't have a point)

    I don't know if these reforms are just window dressing or not, but they shouldn't be confused with a philisophical aversion to short selling

    however, middle-class investors were unable to enjoy many of the benefits of short-selling.

    It didn't take me all that much effort to have the short-selling ability (which includes margins and basic options) on my internet brokerage account. The normal limit on what a 'middle class investor' can do is because of the tax distinctions between an 'investor' and a 'day trader'.

    I would also say that short-selling is by definition 'speculating' rather than 'investing' (especially since you can lose more than you put it) but since I also think people should be able to do what they want, it's a rather trivial point.

  9. The impression i got when watching Stewart v. Cramer was that Jon's parents lost a good chunk their retirement money (he actually mentioned that). That, to me, seemed to be underlying reason why he's so pissed off at Cramer.

  10. The problem isn't short selling.

    Its not even, really, the lack of an uptick rule.

    The problem is naked shorting, which is fraud. Naked shorting is also known as "failure to deliver." When Lehman was the victim of a short attack, over 30,000,000 shares were sold and not delivered to buyers.

    My limited knowledge of the inner mechanics of short selling makes me wonder how naked shorting is even possible.

    When I short, I have to borrow the shares from my broker. Last December, there were stocks you couldn't short, because no shares were available to borrow. When you do short, you are always (theoretically) at risk of having your broker close your short for you because it needs the shares back.

  11. RC,

    An aside. I heard you graduated Harvard Law. I used to work with a Harvard Law graduate named Jim Wolf. Great guy. Any chance you know him? His dad was an attorney as well, but became one so long ago that he became a NY lawyer via an apprenticeship

  12. FYI Stewart's brother is Larry Leibowitz, the head of US Markets & Global Technology at NYSE Euronext. Supposedly, his brother was prepping him for the interview.

    bunch of ignorant douche bags

  13. Shorting against viable companies isn't a vialbe strategy long term though. And shouldn't matter at all to regular investors but only matter to traders.

    IE, if you are investing for the long term, short term stock flucations whether due to shorting, or just normal market volatility should be irrelevant.

    For people that are trading, they will either have stops in place, or quite probably turn around and short the stock themselves.

    Also, IMO no realy problem with naked shorting. Lehman's problems weren't due to shorting, but due to massivly bad investments. If the company had turned out to be in a good financial position the shorters just would have lost their asses.

  14. yes, the article misses the real point of naked short selling and the uptick rule.

    the topic reason should address is how naked short selling wouldn't exist if the government didn't protect brokers that lend shares without expecting get the money before settlement.

  15. I fully and totally disagree and I have been in markets for 20+ years. Shorting of equities as it exists now provides an easy path to a liquidity death spiral. And in addition to the naked short selling where attempts are not legitimately made to borrow shares, we now have to endure shorting via various flavors of swaps.

    The quaint notion that anyone who is long needs the input of a short seller to wake them up to potential problems is another darling of the shorts are needed! crowd. No, they are not. Shorts have access to the same information everyone else does (or do they have an illegal inside track?) and as such longs will begin to sell as bad news emerges and eventually the number of new buyers will dissipate until a new 'fair' level emerges.

    Answer this - when short selling was far more restricted (not that many years ago in fact), did stocks not decline in price? What about the early 1970s? Did the market need unfettered short selling to tell it things were bad?

  16. Shorting isn't the problem with this economy. Naked shorting isn't the problem with this economy (but should be criminally punishable, as it is fraud.) Shorting and spreading rumors isn't the problem with this economy (because most terrible rumors have turned out to sound more like pipe dram rosy scenarios after a few months.)

    The problem is that people were irrationally exuberant. It's too bad they're not being fully punished for it. There's no rational basis for AIG shareholders to still have a 20% stake. 20% is about how much the counterparites should have gotten in liquidation.

  17. mike,

    I am unable to argue the merits or morals of short selling as it stands, but I can argue incentives. As long as there is no way to profit from a drop in the price of an asset, the bubbles will last longer and get bigger and failing businesses will flounder longer, exacerbating the losses and waste.

    Currently, there are no incentives and ample punishments for organizations or industries that are doomed to eventual failure to gracefully contract. Short selling is one of the few, if perhaps the only, incentive for at least someone to point out that the emperor is naked.

    The shareholders and the officers have ample negative incentive to acknowledge that their trading price is a sham. The only stimulus for shareholders to sell is fear that they'll be left holding the bag, but if they are the first to sell, the bogus price may continue to rise for a few more months.

  18. I like Jim Cramer for his investment advice. He IS a good stock picker and in his books he gives rules that would have saved most of the people that lost their asses: diversify, homework, divest from stocks as you approach retirement, etc. He knows how Wall Street is structured but he IS NOT a macroeconomist and should not be held responsible for a stock market crash when told people to get out.

  19. Gosh I hate to argue this with someone more knowledgeable than myself, but:

    Shorting of equities as it exists now provides an easy path to a liquidity death spiral.
    What is a liquidity death spiral? Do these financial firms rely on the stock market for their operating cash or something? (And totally hypothetically,) If I were the CEO of a company whose stock was being heavily shorted, and I knew the company was financially sound, I'd instruct the company to buy buy buyback shares, and profit.

  20. mark - not to speak for mike, but I think the idea is that a lot of companies need equity to have collateral for any loans. So if you push down the value of a company's equity, their ability to borrow will be restricted. If you keep pushing, the banks may call in existing loans, squeezing the company for necessary funds.

    While there is some truth to that, a problem with the idea is that most banks are more interested in cash flow than equity. If a company can prove positive cash flow, most banks will at least allow the outstanding loans to float, even if they have a problem with loaning them more money.

  21. Damn straight mark!

    When people buy stock, they are essentially claiming ownership to a percentage of the production process. After all, it is production that leads to the accumulation of wealth. But if a company's money flow is completely dependent on new investors buying their stock, as was the case with MANY online businesses during the Dot.Com bubble of the 90s, then it SHOULD fail when their stock collapses to mere short-selling!

    Besides, the brokers that lend the stock in short-selling have to buy it first right? That necessarily drives the price upwards. So in the end this whole short-selling business actually balances things out.

    Besides, it is the right of these brokers to lend their property just as how it's the right of a banker to lend his money. When I take a loan from a bank, I will "sell" the cash in exchange for capital goods in order to repay the loan later through better methods of production. That necessarily drives down the value of the dollar. However, I would "buy" things with that dollar, and their value would therefore rise. What we have in effect is a transference of value in the market, which is apparent in short-selling and buying alike. It's not done through theft, but through choice, therefore the stigma attached to it is unwarranted.

    I do share the same concern over fraudulent exchanges of any form as others have mentioned, but when anyone buys a stock I would hope they do their homework on the company's business fundamentals instead of following the herd.

  22. All shorts are not created equal. Naked shorts pose an issue. The ability to de facto increase the amount of a companies equity being traded, which in effect dilutes the share price, is a problem. Trading on something you don't hold or don't have a mechanism to hold in the future, ensuring the stock you are selling actually exists, is inherently destructive regardless of what you are trading.

  23. Short selling should be banned. Would it be ok for me to borrow my neighbors house and sell it and wait for the market to go down(while talking about how BAD this house is) and rebuy it at a lower price and give it back to them and at the same time make a profit. How absurd does this sound. There are many other ways to gamble in the market and make money(put options) off a company that is nonperforming. There are too many games being played with main streets hard earned money. ENOUGH

  24. The problem is not everyone will believe you that his house is bad. You are not the sole source of information nor the sole variable in evaluating the price of your hypothetical neighbor's house. Short selling has its place.

    You presented the largest problem with people understanding short selling and a lot of market related ideas. Somethings, like short selling, do not lend themselves to being "dumbed down." Somethings have to retain their complexities and context to be properly understood.

  25. I agree that fraudulent forms of shorting-selling should be banned, but banning all legitimate and honest forms of short selling? I don't think so!

    Tell me, those of you who argue for a universal ban on shorts, what specific concern do you have for shorts? Is it the lending (which is a right of the broker) or is it the selling? If it's the lending, why is it okay for you to take out a loan from a bank but not okay to take out a loan in stock? If it's the selling, why is it okay for you to sell your home but not okay to sell stock? Such hypocrisy!

    "Short selling should be banned. Would it be ok for me to borrow my neighbors house and sell it and wait for the market to go down(while talking about how BAD this house is) and rebuy it at a lower price and give it back to them and at the same time make a profit. How absurd does this sound."

    Are you suggesting that it should be banned because it's "absurd"? The last I checked, our laws were supposed to protect our liberties, not to thrust down our throats a single-person's ideology. You have a problem with me lending someone my stock, or my home, to be paid back later? Tough cookies! It's my property, and I have a right to take such risks. Besides, most (if not all) lenders typically charge a fee or interest on the thing they lend in an attempt to make a profit and to minimize any losses.


  26. I watched the stewart interview and didn't come away from it as attacking short selling. in fact, none of my friends did.

  27. I'm currently shorting Reason and Cato and going long on Lew Rockwell and Peter Schiff.

  28. Your article misses the point: short selling is fine and a valuable way of deflating bubbles. Short selling on the side while going on television and encouraging your viewers to buy or short selling while spreading lies about the company- and then going on tv and bragging about those lies- is fraud.

  29. The issue that Stewart exposed was that insders like Cramer '06 were using questionable business practices (false rumors) to turn a profit. On that point I agree with him.

  30. While short selling should be defended, I am afraid we are missing the boat on some of the associated problems that people are legitimately complaining about. If we do not address things like naked short selling and the criminal spreading of rumors that are known to be false, then momentum will gain for banning short selling altogether. We need to pull our heads out of the sand and start providing answers to these problems instead of just expecting everyone to go along with us just because the free market is obviously good and right.

  31. Good article, except for the author's mystifying suggestion that shorting of mutual funds should be allowed.

    It is mystifying because mutual funds are an anachronism in todays market. There are so many exchange traded funds (ETFs) that can be shorted, why would you want to short mutuals (which are redeemed at NAV, not sold at market)?

    You can short the whole market or practically any segment of it with "reverse" ETFs, some are 2X or even 3X "shorts". Again, why would you ever want to short Mutuals? Strange idea.

  32. Good article. Stewart definitely did short selling a disservice. It does send important market messages. More importantly, short selling is not likely to cause trouble for average joe 401k holders. Short selling is very risky. Whereas when someone buys long, they can only lose what they put it, when someone sells short, if they try to short a stock of a good company, there is literally no limit to the amount of money they could lose, since there is no limit to how high that stock can rise. Even more to the point, when someone tries to short sell a good company, it is not going to take long before long buyers are going to take advantage of the depressed prices and drive the price back up. In this case, short selling has zero effect on the value of people's 401ks, the contents of which for the most part are not bought and sold minute to minute.

  33. I 100% agree with this article. During that show I had to pause it to explain to the people I was watching it with what short-selling actually entails and why it's important, valuable, and not at all the sinister practice it's being framed as. The trouble is people like Cramer who use their media presence and connections to create situations in the market that aren't reflective of the actual value of a stock, using techniques like short selling and options trading to capitalize on their media positions while flying below the SEC's radar.

  34. I think there's confusion between legit short selling, naked shorts (which game the system) and being a "short" with respect to a stock or sector.

    When Cramer buys short or tells folks to sell an investment (naked or otherwise), he's being a "short" (in contrast to a "long" who believes in the ongoing prospects of an investment). The problem is that many "shorts" spread rumors (as Cramer admitted doing) which can rise to the level of fraud.

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