(Drivebycuriosity) - There is a cult around short sellers. These people are betting on falling stock prices (by going short or shorting). They borrow stocks
from a bank and sell the shares immediately
in the hope that stock prices will fall and then they could buy back
these stocks for much less.
Famous short sellers like Jim Chanos, Bill Ackman, Whitney Tilson & Carson Block are celebrated in the New Yorker, Bloomberg, Business Insider and other media (
bloomberg). Some are treated like rock stars (
features). The influential magazine The New Yorker claims, "shorting helps counterbalance investor overconfidence, corporate puffery, and Wall Street’s inherent bullish bias" ("In Praise of Short Sellers"
newyorker). The magazine also declares that shorting "contributes to the diversity of opinion that healthy markets require".
Feral Hogs
Does it? The graph above shows that short selling (measured as the so-called "short-interest") has been shrinking during the current bull market for stocks. It looks like short sellers had to cover their bets (and to buy back) as stock prices have been climbing in order to limit their losses - which could amplify the upwards trend. But history shows, that short sellers are getting much more active when stocks are falling. For instance the correction in early 2016 inspired George Soros and many others to short the US stock market (
driveby). As a consequence the short sellers aggravated this dip. But they had to buy back as stocks recovered later in 2016. So, short sellers are amplifying the stock market fluctuations instead of smoothing them.
History shows that short selling gets more intense when stock prices are in downwards trend - which could lead to a snow ball effect. In the recession of 2008 and early 2009 short selling was a viable
business model. Hedge funds and other speculators were betting
on a meltdown of the market and were shorting it. Massive shorting accelerated the fall of the
stocks which intensified the pessimistic sentiment and inspired so more short selling, creating a snowball effect. It worked temporarily as self-fulfilling prophecy.
After the bankruptcy of Lehman Brothers, which brought huge
gains for short sellers, groups of short sellers tried to repeat their
success. They attacked everyone who seemed vulnerable, especially the banks. Federal Reserve member Richard Fisher (Dallas
Fed President) described these groups as " big money" that "does
organize itself somewhat like feral hogs. If they detect a weakness or a
bad scent, they go after it" (
marketwatch ).
These massive bets against banks and many other companies destroyed not
just the trust into the attacked firms, these bets destroyed the trust
into the whole economy. Bankruptcies and tumbling stock prices seemed to
confirm those attacks. Thus the stock market got into a downward spiral which
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. The destruction of trust lead to spiral of
pessimism that almost sucked the whole economy into the vortex of a
depression. In spring 2009 massive stimulus programs (QE) and a zero
interest policy stopped finally the downward spiral.
Rumors & Allegations
Even in a sound economy can short sellers do a lot of damage. This is described in the James Bond movie "Casino Royale". A villain, named "Le Chiffre" shorted stocks of an airline and ordered then an assassin to bomb a big new passenger plane in order to destroy the whole company and make their stocks worthless. Just fiction? Not really. Last week in Germany a man was arrested for a bomb attack (
reuters). He had purchased put options on shares of the soccer club Borrussia Dortmund, which gave him the right to sell these shares to a certain price. Then he detonated three bombs that targeted the club`s team bus in the hope of forcing down the club's share price and making a profit. "If the shares of Borussia Dortmund had fallen massively, the profit would have been several times the initial investment," the prosecutor's office said, adding that such a slump could have resulted if any players had been killed or seriously injured.
All short sellers benefit from falling stock prices. Thus they have a
natural interest that the business of the shorted company fails. Even if short sellers do nothing illegal they can inflict a lot of harm by spreading rumors & allegations about the shorted company- a practice dubbed “short and distort”. This way they can ruin their reputation and irritate customers, creditors, investors and employees and so inflict harm onto the company.
Often short sellers appear on TV or they give interviews after shorting to "explain" their case. Sometimes they conspire to torpedo share prices in “bear raids.” With false allegations they can destroy good
companies and cause people to lose their jobs. And short sellers are not
regulated the way Wall Street analysts are, so they aren’t as
accountable (
bloomberg).
Short sellers are often very powerful and exert a large influence on the
stock market. Bill Ackman, a
hedge fund billionaire and CEO of the hedge fund Pershing Square
Capital Management, has been betting big against Herbalife, a producer and
seller of nutritional supplements, for years. In December 2012 Ackman revealed that had massively shorted stocks of Herbalife and then started bad-mouthing the company. "To bring the stock down Ackman
did not just use his huge reputation as a billionaire hedge fund manager and media star. Ackman´s team has organized protests, news conferences and letter-writing campaigns
in California, Nevada, Connecticut, New York and Illinois, against his
victim " wrote the
New York Times (
nytimes). He also pulled the political puppet strings and got support from leading politicians including a senator.
Short sellers don´t invest, they don´t support economic growth, quite contrary, they punish companies who´s management thinks long term and invests into the future (which often reduces gains in the short term or even causes losses). Short seller can discourage CEOs to invest and to create new jobs because the
implied costs could provoke attacks by short sellers. Short sellers could slow down economic growth - and they make any crisis worse. I think these are enough reasons that short selling should be illegal or at least constrained and scrutinized like the work of analysts.
