(Drivebycuriosity) - "Every stock market party needs a short seller", claims Bloomberg (
bloomberg). Short sellers borrow stocks from a broker and sell the shares immediately (going short or shorting) in the hope that stock prices will fall and then they could buy back these stocks for much less.
Noah Smith, column writer for "Bloomberg View", asserts (following ideas of scientists like Eugene Fama) that short sellers could prevent stock bubbles, because they would sell when stocks are overpriced. These sales would lead prices back to a reasonable level. But, in reality there are bubbles because short sellers are disadvantaged, Noah laments. Going short has extra costs, compared to going "long" (buying stocks), he writes, quoting an academic paper: "Usually, dealers charge only a very small fee when they lend out shares of stock to short-sellers. But occasionally, these fees can shoot up to astronomical levels, before the short position is closed. That creates a huge risk for a short-seller". Noah also complains that brokers can call back their stock loans at any time, before the wager of the short seller bears fruit.
Noah demands that short sellers have to be supported and recommends "to enable short-sellers to do their job". For instance by creating "centralized exchanges for lending stock shares". This would "would vastly increase the ability of shorts to borrow".
Feral Hogs
I don´t buy his arguments. First I don´t believe that short selling necessarily creates reasonable prices. In the panic of late 2008 and early 2009 - as the stock prices were already down and still falling -, herds of short sellers massively dumped stocks and sent stock prices further down. Massive shorting enhanced the fall of the stock market, created panic and downward spirals for almost any stock on the market. This led to ridiculous undervalued stocks in spring 2009. This under valuation made the massive rally since then (plus 190% plus) possible. The stock market crash was at least aggravated by excessive short selling that paralyzed the whole economy. Companies ceased investing & hiring, the recession was on the brink to turn into a disaster like the great depression of the 1930s
Further, I don`t believe that short sellers are disadvantaged and need support. Shortly after the bankruptcy of Lehman Brothers, which brought huge gains for short sellers, groups of short sellers tried to repeat their success. In the months after Lehman´s fall herds of them - hedge funds and their followers - attacked everyone who seemed vulnerable - almost any bank had to be saved. Federal Reserve member Richard Fisher (Dallas Fed President) described this species as " big money" that "does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they go after it."
Short sellers are often very powerful and exert a large influence on the stock market - contrary what the Bloomberg article wants us to believe (
driveby). Many hedge fund managers like Jim Chanos, David Einhorn of Greenlight Capital and others practice massive short selling and try to manipulate stock prices by accusations. Take for instance William A. Ackman. The hedge fund billionaire and CEO of the hedge fund Pershing Square Capital Management is betting big against Herbalife, a producer and seller of nutritional supplements traded on Wall Street. In December 2012 Ackman revealed that he had shorted massively stocks of Herbalife and then started bad-mouthing the firm. To bring the stock down Ackman did not just use his huge reputation as a billionaire hedge fund manager - there is cult around short sellers like Ackman -: "His team has helped organize protests, news conferences and letter-writing campaigns in California, Nevada, Connecticut, New York and Illinois, against his victim - although several of the people who signed the letters to state and federal officials say they do not remember sending them" wrote the New York Times (
nytimes). He also pulled the political puppet strings and got support from leading politicians.
I don´t think that short sellers need support. They don´t invest into the economy. They don`t support economic growth and they do nothing for the rising wealth of the nation. The harm they can do is dramatized in the James Bond movie "Casino Royale": The villain, named "Le Chiffre", shorted stocks of an airline and then ordered an assassin to bomb a valuable new plane in order to destroy the whole company. This is just fiction, but gives an idea how short sellers could work. Even when short sellers do nothing illegal they can inflict a lot harm by spreading rumors and allegations which can ruin the reputation of a company and thus irritate customers, creditors, investors and employes and so inflict damage on the company.
Supporting short sellers would mean strengthening the followers of Ackman, Chanos and other professional short sellers who try to destroy value. This would enhance the frequency and intensity of short raids against companies. CEOs would be discouraged to invest and to create new jobs because the implied costs could provoke attacks by short sellers. Therefore supporting short sellers could hamper economic growth.
