Short Sighted
A few months ago, some government economists blamed the rising price per barrel of oil on short sellers and speculators. I thought that was absurd (and this Slate article makes a good summary of the arguments).
This week, the SEC enacted a ban on short selling on shares of 799 financial companies. The SEC admits that the list was hastily generated, and many companies left off have lobbied to be included.
The company where I work, TiVo, has always had a large short interest. The same is true of many start-ups and tech companies. When there’s good news, and a short squeeze is applied and a gain becomes a giant gain, I’m elated. When the news isn’t so great, and the short interest widens and a loss becomes a bigger loss, that obviously affects me the other way. (“Sorry kids, no Disneyland trip this year. Damn those short sellers!”)
I do agree that short sellers can create an incentive to manipulate a market, and having negative energy out there does seem to lead to some bad behavior on an individual basis (where investors with an axe to grind and a short position may even manufacture falsehoods to convince others to sell). But that’s hardly widespread, and hardly makes a big difference in the long run. At worst it adds volatility.
If short sellers damage oil futures and create turmoil in the financial sector, why isn’t it equally true that they act against the best interests of the entire stock market? Why ban in just one or two sectors, and let short sellers run rampant everywhere else?
But I’m not actually arguing that short selling should be banned. I find the current ban absurd — and not just because it’s limited to one or two sectors.
The fact is, free market works. if a significant chunk of investors argued that a particular company would fail — and more importantly, backed that up with money betting the stock would fall, maybe instead of “speculation,” it’s because they’ve done their due diligence and actually believe the company is making mistakes?
We have a long tradition of letting people bet on the loser. What if Vegas suddenly said you couldn’t bet on the Don’t Come line in craps?
The current administration has so little faith in our economy and the financial sector that they have to change the rules in order to prop it up. That’s what’s terrifying: It’s a startling vote of no confidence.
Best would be to leave the free market alone. Next best (but not smart at all) would be to ban short selling, permanently, for all sectors. What actually happened is a far, far more unfortunate alternative.
September 20th, 2008 at 2:53 pm
I don’t blame the short sellers for the problems in the larger market, but there’s no doubt in my mind that many tech companies have been subjected to unfair bear raids. This is especially true of the small cap companies where it takes very little to move the needle. A falling stock price can create a self fulfilling prophecy and when money managers with extreme amounts of wealth are able to punish a stock without impunity it certainly distorts the true value of the underlying company. The solution for companies is to focus on their business and prove them wrong, but as the hedge fund industry has grown we’ve seen more and more abuses take place.
Even more concerning than the shorts though, are the phantom equity and bermudian options that are allowed to be underwritten on the very same stocks that have seen these raids. If a company wants to dilute their equity that’s between them and their shareholders, but when major investment banks are able to create synthetic shares, it allows them to dilute other equity without the company in question benefiting from the cash that comes from these underwritings.
When the ordinary investor is told that there is only 100 million shares outstanding for an issue, but there is really another 900 million unregistered and unreported derivatives trading in the market, then how is it fair to those who don’t have access to this information?
Banning short selling isn’t the solution and people should be allowed to bet on the don’t pass line, but shorts should have the same reporting requirements as longs. If someone’s bet more then 5% of a companies stock that they’ll fail, how are they not considered any more of an insider then someone who is long 5%? Likewise, if someone owns more then 5% as a result of a derivative bet, then why are they not considered an insider just because these are legally classified as “bonds.” There are no easy answers to these issues, but until they start to regulate the derivative market, no one is going to know what reality is.
September 20th, 2008 at 8:38 pm
I agree with your points (and you’re far more familiar with the market than I am). If the SEC had acted to put fair and equitable controls on short sellers, I’d applaud. But this emergency ban for a half-vetted list of 799 financial stocks reeks of the worst kind of desperation.
September 21st, 2008 at 12:30 pm
I agree that it’s bad the US Govt had to step in and change the playing field to prop up the market.
However, I don’t have as much faith in you in the stock market being the driving force in our economy. There’s too much short-sighted self interest (rather than long term company well-being) which results in CEO’s selling a company up the river, while making millions after 1 year of tenure.
Not being a finance guy…I can only wish there was another type of market companies could join which would still allow the average investor in, yet not subject the company to the volatility after one non-record breaking quarter.