Shorting the Shorts
20 November 2008Today, Citigroup begged the U.S. government to reinstate the ban on short selling in the financial sector. CNBC ran an interview piece on shorts yesterday, with experts generally agreeing that drops of over 15-20% per day in a stock was not because of value, but could only be because of shorting.
A day earlier, a US investment expert (in London at the moment) exhorted the US audience at MSNBC to reinstate the “uptick rule”, one of the many regulations cleared away in the last few years, which prevented shorts from just piling on without an interim uptick. Citibank asked for the same assist today.
Finally, John Bogle (Vanguard co-founder) has now come out strongly against what I’ve been calling Vampire Investors; he figures they take about $600B a year out of the US financial system, without adding value. He actually says they subtract value.
One of these classes of Vampires are a certain category of shorts.
One view of shorts is that they are the other half of a natural balance: long vs. short. Simple, eh?
Another is that they form a necessary part of any arbitrage play, and so provide natural risk aversion and stabilization to — to what? To individuals, hedge funds, or the market?
I would suggest that the natural balance of things is represented not by long vs. short, but by buy vs. sell.
Shorts operate in various ways, but the most insidious, I think, is the Jackal Trade, where you see a whole bunch of jackals pick a target (in the last few weeks, we’ve seen a long list of examples in the financial sector), and then attack it in concert, driving the price down even as they make money on the decline.
Does this add value? No. Does this stabilize the market? Just the opposite: it is perhaps the primary danger equities markets face today. Can we count on the self-interest of shorts to stop doing it when it endangers otherwise-healthy companies, or even whole market segments? Obviously not; they won’t stop as long as there is money to be made - and why should they?
Australia outlawed shorts in September.
I think it is time for serious consideration to be given not just to stopping shorts in the financial sector, but in the markets. Perhaps there is some alternative way to provide some hedging range of offlaying risk, without allowing shorts to drive global banking stocks down 40% in a day. If so, fine.
But the SEC and friends have to bring this carnage to a stop. It has nothing to do with capitalism, everything to do with market manipulation, and it is wreaking incredible damage at a time when we need serious repairs.
8 Responses to “Shorting the Shorts”
November 21st, 2008 at 2:06 am
Hedga Fundus Carta
We have seen the Great Charter of the Lord Paulson, sometimes King of the Treasury, our bank-funder, of the liberties of hedge funds in these words: Paulson by the grace of the market, regulators, SEC officials and other our faithful subjects, which shall see this present Charter, Greeting. Know ye that we, unto the honour of Almighty Alpha, and for the salvation of our alpha and the alpha of our progenitors and successors, to the advancement of our wealth, and amendment of our financial realm, of our meer and free will, have given and granted to all regulators, SEC officials, and to all free institutions of this our financial realm, these liberties following, to keep our hedge fund kingdom forever.
Treasury Sec Hank Paulson said yesterday he wants hedge funds and other financial institutions to be required to obtain charters allowing for oversight.
http://ftalphaville.ft.com/blog/2008/11/21/18524/hedga-fundus-carta/
I wonder if the Charter will cover shorting? Tim
November 21st, 2008 at 5:34 am
Dollar Strength Sustainability
by London Banker
Coincident with the passage of the Paulson Plan in early October, the top prime brokers (MS, GS, JPM) issued margin calls on hedge funds which raised the average margin required from about 15 percent to about 35 percent. At a time of fragility in global markets and global confidence, this was equivalent to the sudden contraction of global market liquidity by a trillion dollars or so. A huge sell off in quality assets followed as hedge fund managers struggled to meet the margin calls.
http://londonbanker.blogspot.com/2008/11/dollar-strength-sustainability.html
Without commenting on Shorting (wink, wink), this is a neat piece on why some markets have plunged. Note the implications for the US$. Tim
November 21st, 2008 at 12:12 pm
Do We Need to Cancel ALL CDS Contracts?
By Chris Whalen - November 21st, 2008, 12:00PM
Last night, I gave a presentation to the New York Chapter of the Risk Management Association regarding the US banking sector and the long-term issues facing same.
Excerpt:
Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion in CDS payouts? Remember, less than 10% of these positions are actually hedging exposure. The rest are speculative.
My answer is that we pay the hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches anbd pitchforks catch up to them.
Mark, Different subject but similar theme. You and Whalen might be on the same wavelength. Tim
http://www.ritholtz.com/blog/2008/11/do-we-need-to-cancel-all-cds-contracts/
November 24th, 2008 at 5:53 am
Finance Has Lost Sight of Its Role
from naked capitalism by Yves Smith
Excerpt:
In 1980, financial firms accounted for 8% of S&P earnings. During the peak of our last stock market cycle, their profits were over 40% of the total.
http://www.nakedcapitalism.com/2008/11/finance-has-lost-sight-of-its-role.html
Finance is essentially parasitic in nature to it’s hosts (or should be), the real economies. Wall Street enterprises are still being regarded as too important, witness the Citi bailout/fudge (Wells Fargo next?). The banking industry, as I’ve said before, needs a serious cull and separation of functions (http://www.voxeu.org/index.php?q=node/2605) Tim
November 25th, 2008 at 5:26 am
Anatomy of a panic? The collapse of Morgan Stanley
by Sam Jones, FT
From the WSJ: It turns out that some of the biggest names on Wall Street — Merrill Lynch & Co., Citigroup Inc., Deutsche Bank and UBS AG — were placing large bets against Morgan Stanley, the records indicate. They did so using complicated financial instruments called credit-default swaps, a form of insurance against losses on loans and bonds…
…during those tumultuous few days in mid-September, the swaps market turned on Morgan Stanley like a financial Frankenstein.
Excerpt:
The picture is much more subtle and insidious than the WSJ and Andrew Cuomo et al make out. Sure there was a panic at MS - and a run on the bank - but it wasn’t caused by some cabal of CDS traders, or puppets whose strings were being pulled from the C-suite floors of rival banks. It was just a perfect example of human behaviour - and a series of fallacies.
http://ftalphaville.ft.com/blog/2008/11/25/18667/anatomy-of-a-panic-the-collapse-of-morgan-stanley/
November 25th, 2008 at 9:47 am
Yes, Bear raids and jackal trades, are an issue. They flood the market with fake liquidity and force a stock down until it hits stop loss points and other triggers that force other investors to sell. Basically if it works it sets off a vicious self reinforcing decline.
BUT! This strategy is not one without risk to the short seller. Witness the incredible short squeeze on Volkswagen. Remember, short sellers need to eventually buy back the shares they sell.
So suggesting that short selling has caused the collapse of BS, Lehman, and now Citi, is wrong. It was the decisions of the greedy management/boards in the first place that set the stage for the company collapse. When you are levered 30-1 or 40-1, it doesn’t take much of a downturn to wipe out your equity. All of those companies were simply walking dead. The shorts may have hastened the final breath but they are not the ones who put the companies into a precarious position in the first place.
IMHO, the concept of a short sale, or a put option (bet to the downside), are not in and of themselves a problem. I believe they are valid market tools. Why should an “investor” only be allowed to bet on a stock going up? Betting long or betting short are ALL simply speculative bets. They create no true value. To me, unless you are in investor in an IPO or a private placement, any and all trades in the “market” are speculative trades.
So if you have a problem with “speculation” then do away with long trades as well because they don’t add value either. Do away with public markets. If you think that is too radical, then you must allow both long and short trades.
Mark, given your biology background, surely you can find examples in nature for the concept of short trades and short raids? How about when a pack of hyenas attacks the slowest or the sickest? What the benefit? perhaps it Culls the heard and leaves more resources for the rest?
Should there be rules to stop a bear raid. Perhaps. Perhaps rules to simply slow them down a bit so they can’t overwhelm the ability of strong companies to survive, ie an natural market response when buyers step in and push the stock higher because they know the shorts are wrong. Perhaps an uptick rule, and maybe a ban on naked selling. But banning shorting outright is a mistake. IMO.
Perhaps the simplest way to stop a short seller is simply to not lend them the stock to Short. If all of the funds and stock holders who were long an equity simply refused to lend the stock to short sellers, or called in the shares already lent out, the problem would be basically solved.
But with BS, Lehman, Citi, etc, these companies (and many others to come) were already dead.
November 25th, 2008 at 10:26 am
Nov 25 2008 11:23AM EST
The Broken Treasury Market
by Felix Salmon
If you want to worry about naked shorting, don’t worry about the stock market, where it’s vanishingly rare. Worry instead about the Treasury market, where it’s a major problem.
Helen Avery has a huge and important story up about failures-to-deliver in the Treasury market. It’s crucial that there be trust in the Treasury market, but right now, with fails reaching the trillions of dollars, the market is looking increasingly broken.
Conclusion: The Bond Market Association seems to be the villain of this story, consistently pushing back against attempts to impose steeper penalties on brokers who fail to deliver Treasury bonds they’ve sold. And of course there’s the general deregulatory trend of recent years, which has mitigated against new regulations. But this should be a top priority for Treasury and the Fed, now. This is not something to wait until January.
more: http://www.portfolio.com/views/blogs/market-movers/2008/11/25/the-broken-treasury-market?tid=true
November 25th, 2008 at 11:52 am
Tim,
From the same site you just posted a link to, here is a comment about short sellers perhaps not being the problem.
http://www.portfolio.com/views/blogs/market-movers/2008/11/25/demonic-short-sellers