Are Short Sellers Really to Blame?

Sometimes I think that the markets and politicians are out of touch with reality; how else do you explain the trotting out of the same old tired "short-selling menace" dead horse, as if the collapse in the share prices of the mortgage GSEs, Lehman (LEH) and AIG (AIG) was the fault of short-sellers and not because the companies were insolvent?

I repeat the companies were insolvent and their stock is now priced accordingly. It's as simple as that, remove short-sellers from the picture and the end result is identical. To claim otherwise/blame short-sellers, is to say that Lehman could've been insolvent for months on end and still have a healthy stock price if those pesky short-sellers weren't in the picture.

Some of the people complaining about short-sellers act as if no one ever sells a stock of a struggling company as part of cutting their losses as opposed to doing it as part of a short-sale; not to mention the fact that there is always a buyer at the other end of any sale, whether it's to take profits, cut one's losses or sell short.

Did any of these people consider that the massive selloff in certain financial stocks is really about legitimate worries about the solvency of various companies, general fear about the markets and people trying to cut their losses? Wasn't it a perfectly rational decision to liquidate one's position in AIG or Lehman over the past couple of weeks due to their weak financial position/pending insolvency?

Would any of the people complaining about short-sellers have held onto a position in AIG this past Monday?

From my perspective the whole thing reeks of desperation and an unwillingness to accept the fact that the financial world is riddled with insolvent and near insolvent companies, so they seek to find a scapegoat to blame for declining stock prices. Personally I think the argument loses quite a bit of credibility when it's mostly focused on financial  stocks as opposed to stocks in general. Why aren't people railing against short-selling in retails stocks or the stocks of any of a large number of troubled sectors? 

Mind you I'm not saying that no short-seller has ever skirted the rules, spread rumors or otherwise engaged in malfeasance, however it's not as if people on the long-side never break the rules either, AND most importantly we're talking about companies that are insolvent. Like I said before it's not as if all it takes is the removal of short-sellers for an insolvent company to have a healthy stock price, the only people responsible for taking these companies down are their incompetent managers.

The Lehmans of the world aren't the victims, they're the Villains.

I wonder who will be the scapegoat when short-selling is banned and stocks are still sinking into the basement?

Disclosure: none.

Comments

[Roowns:]

True True. But it gives time for Fed to raise money from the market to keep fighting another day. That's all they can do right now.

2008 Sep 19 06:52 AM

[pgx:]

You're right but I do wonder about the naked shorting. Since they are unable to enforce the rules against it, things can get uglier than they actually are.

2008 Sep 19 08:29 AM

[URASlimyWeasel:]

Ok, so you're a short seller that's made lots of $$ from preying on companies under duress. Your practice *MAKES* companies insolvent. Morgan Stanley is a great example. They announce near-flat (i.e. outstanding) earnings in a *bad* quarter , have boatloads of cash onhand, etc. HOW IN THE *HELL* CAN YOU CALL THAT INSOLVENT??? The only thing I'm hearing from your article is how vermin like you can justify anything to themselves in the name of personal profit.

2008 Sep 19 08:34 AM

[Fabien Hug:]

I still think that short sellers are disruptive to the market. However with shareholders being so lame or having no say in the running of a company, they are kind of democracy. I am a small co-owner of BoA and for instance, I wouldn't have approved what was decided this week-end.
My only option, sell and think about something else. On the other end, when you look at GS or MS, things go a bit too far. Even if the short are proven wrong, these erratic stock prices are unbearable for the investors who count on financial markets to finance whatever they need in the future. As an analogy it looks to me like if car sales people would not be bound by speed limits because they know better. That's why governments have to put some rules otherwise the masses will not go on the markets anymore. As a result people will hoard of their money with the consequences we can imagine.

2008 Sep 19 08:59 AM

[nervousFella:]

The author of this article misses two points.
In short selling, there isn 't necessarily always a buyer. The exchange has something called a market maker, who in order to keep the markets liquid, is always a buyer or seller of any listed stock. THAT is whom the short seller is selling to. In naked shorting, the market maker isn 't allowed to impose the rule as to whether the stock he is buying from the short seller is actually available to be traded.

Secondly, the reason why the shorts are concentrated in the financials is that shorting becomes a self fulfilling prophecy. Banks can borrow based upon there market value. If their stock is naked shorted, it FORCES the stock down, which means it now becomes more difficult to borrow or even keep it 's existing loans. If the value of the stock drops below accepted margin value, other banks are forced to ask for their loans back. This automatically hampers the ability of the bank to do business which forces the stock lower and repeats the vicious cycle.

Non financial companies are less susceptible to this. If the stock of a company plumments, it might hamper its ability to borrow against the stock BUT it doesn 't stop from selling iPods, mine potash, manufacture cars and make money. Eventually, the shorts will force the stock so low, that the company 's real assets are worth more than the stock. At this point buyers will move in and the stock will not go any lower. The shorts will be forced to close out this position and if naked shorting was involved, the shorts will find there is not enough stock to close out the position and this will cause the stock to skyrocket.

Naked shorting only works in the long run IF the company is run out of business since then the positions don 't have to be closed.

2008 Sep 19 09:32 AM

[farmer448:]

Short Sellers certainly are not helping the crisis, much less following the law. I know the SEC is the blind leading the blind but naked shorting is illegal.

2008 Sep 19 09:34 AM

[Lansingman:]

Any company can be described as insolvent if they hold long term assets which are valued on a short term basis. Short selling just ratchets up the pressure of short term valuations. If we want companies to take a long term view we need to reeevaluate the mark to market frenzy caused by short term accounting and investment horizons.

2008 Sep 19 09:55 AM

[HBWOW:]

How do you account for the volatility in hourly, daily volume and price swings without real events for cause or change in price? Look at the
bank stocks last week, yesterday and this morning - crazy. Some
group(s) have to be controling such up and down surges as real events are not the cause when you research for specific reasons for price variations by the minute/hour much less the day. Answer is
market movers and profit takers are in control.

2008 Sep 19 10:02 AM

[Eric Fox:]

There is some misperception by investors on the SEC short sale rule. It only pertains to NEW Short sales - existing positions don't have to be covered.

2008 Sep 19 10:35 AM

[User 265631:]

nervousFella - you hit the nail directly on the head - great description of the threat of naked shorts on financials. The recent sharp downturns in financial companies stock prices, which have almost certainly been attributed in part by short selling, largely created the insolvencies. When a financial company's stock price declines by 50% in a short period of time, it weakens confidence and financial companies are built on confidence. The author presumes that a quick drop in stock price always fully reflects current solvency of the business. Not true - instead it generally just contributes to its demise.

Its unsettling to me to hear people eulogize Bear, Lehman etc. by simply saying these firms took way too much risk and deserved their fate. The fact is, right or wrong, an extremely aggressive market perceived too much risk, punished the stock price (undoubtedly with the help of shorts) and created the insolvencies / liquidity problems. Management failed in both cases in a crisis of confidence caused by the stock price. That is what happened, plan and simple and I'm not quite sure why everyone continues to believe a rational market properly determined these companies' fates. Let's keep in mind that a very solvent Merrill is also gone and MS/GS were next if Vladamir Paulson didn't intervene today. Would that have been a rational market, free of naked shorts, simply punishing insolvent companies? You've gotta be kididng me.

2008 Sep 19 10:46 AM

[jesterboomer:]

Ever hear of a 'run on a bank' triggered by lack of confidence. Those who short financial stocks are also motivated to spew negative rumors in the marketplace. It is not just the act of shorting a stock that is at issue.

2008 Sep 19 11:55 AM

[ResourceWise:]

Mr Lee it would be more useful if you shared your insights on the value added by short sellers to the marketplace. As of now it seems to me that they add 'fuel to fire' and profit from 'making a killing', so I'm pleased that they have been finally reigned in by the regulators - albeit temporarily. Please make the case for Short Selling.

2008 Sep 19 02:05 PM

[williambanzai7:]

Wall Street, Bush, AAA Lawyers and the Demise of Accountability

We live in a time when political and business leaders are able to avoid being held accountable for their acts of gross negligence and wilful misconduct. Sounds like lawyer talk. Well lawyers are intricately involved in this sorry state of affairs. Lets take the Bush administration. What did all the Republican cronies like Cheney learn from the Nixon saga? Don't put yourself in weak position legally. Don't testify under oath, better yet don't testify. Don't provide information under threat of perjury and obstruction of justice, better yet don't provide information. They have artfully avoided political accountability for a litany of constitutional abuses, executive misconduct and malfeasance. They are also getting AAA legal advice.

OK, now lets consider what has happened in the financial services industry. Until recently, our securities laws forced Wall Street to worry about the way it conducts business. Don't play by regulatory rules with origins in Roosevelt's New Deal and sooner or later the SEC or Elliot Spitzer will hunt you down. You had to worry about adequate disclosure and a battery of rules designed to protect average public investors. If you misbehaved, you also had to worry about a ravenous plaintiff's bar charged with the duty of prosecuting claims on behalf of investors unable to fend for themselves (for a generous fee, of course). More AAA lawyers.

Those New Deal rules are still there. However, Wall Street has managed to water everything down to the point where a manmade Katrina hits the financial markets and there is little or no means to hold the perpetrators accountable. Don't hold your breath waiting for the SEC to chase the bankers that designed, peddled and later lied about their exposure to toxic jackass backed securities. What about Credit Default Swaps? Oh, those so called financial weapons of mass destruction are not securities within the meaning of the securities laws. Those are cutting edge risk management tools. How about victims like poor old AIG banding together to sue those who set them up with these improvised financial explosive devices. Never mind, those were sold to "sophisticated" and "accredited" investors able to fend for themselves. Sales to these financial sophisticates are not subject to the same legal regime. We now see that "sophisticated investor" means one who expects to be bailed out by Uncle Sam. Finally, you won't be seeing any widows and orphans starting class action suits, because no one sold them any securities. Instead, they are accused of being financially culpable in this mess because they fell prey to the army of mortgage brokers who aggressively peddled shadow bank loans. Mortgage brokers owned by who else? Wall Street investment banks like Merrill, Lehman and Bear Stearns. Shadow bank loans? Yep, more AAA legal advice.

Let the markets regulate themselves! That is the fundamentalist mantra of the lords of the Street. Well, that is what the market was actually doing until this past Friday. Self regulation came in the surprising form of punishment by the shorts. After all, it was the hedge fund industry, Messrs Einhorn et al, and not the SEC that called Lehman and AIG to the carpet. Not to worry, Mr. Cox, a Wall Street lawyer who runs the SEC, has fixed the short problem for his former clients/masters. Trading bets against financial institutions are now banned. In a comic twist, the SEC is planning to force hedge fund managers to testify under oath. Something more than you can expect from the likes of Harriet Myers, Esq. and Alberto Gonzalez, Esq. Ultimately, the reckless bets that the investment banks made with shareholder capital will go unpunished. Still more AAA legal advice.

Well you begin to see how what seems like one big scam is actually a legally airtight apparatus for screwing Grandma, Grandpa and Joe public in an indirect manner without being held legally accountable. Time to throw out all of the New Deal regulatory assumptions and start all over again. Wall Street, like the Bush administration, has managed to innovate its way out of corporate accountability-- the old fashioned way: hire innovative AAA lawyers. 

One hundred years ago a man named Franklin Keyes, Esq. (you guessed it, a Wall Street lawyer) published a tract titled: "Wall Street Speculation, Its Tricks and Its Tragedies". In it he says: "Wall Street is dominated by some of the brainiest and shrewdest men in the country, natural born sharpers and schemers, and before the average man can get the better of them, except through the merest chance, he will have to eat brain food for a long time." Well said Mr. Keyes. Nothing seems to have changed, particularly the need to hire AAA lawyers.

WilliamBanzai7
September 2008

2008 Sep 21 02:06 AM