(Drivebycuriosity) - Hedge funds are in trouble, at least those who focus on the business of short selling. They had borrowed stocks of GameStock, iRobot, Nokia, AMC, GSX and many other companies and sold them immediately in the hope to buy them back later for a much lower prices. Unfortunately for them a crowd of other speculators started buying these heavy shorted stocks, driving their prices far north.
The rally in heavy shorted stock (short squeeze) served the short sellers a net-loss (gains minus losses) of $54 billion so far (marketwatch ). The banks, which have loaned the stocks, demanded higher deposits to cover the shorts (margin calls) or forced the short sellers to pay the stocks back. In 2020 short sellers lost already $40 billion with bets against Tesla (cnn ). Hedge Fund Melvin Capital lost 53% in January and had to be saved by Citadel, a much bigger hedge fund ( cnn). Notorious short seller Andrew Left, owner of the hedge fund Citron Research, declared that he will discontinue the short-selling-business ( businessinsider).
I think the short squeeze is a healthy purge and long overdue. Short sellers ain`t investors, they don´t invest in companies, they are not interested in success of companies, quite the opposite. Hedge funds like Muddy Waters and Citron Research usually short certain stocks and then they you use social media to spread rumors & fake news and they appear on CBNC & Bloomberg TV and try to talk prices down.
Short sellers did a lot damage in the past. In the recession of 2008 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.
During the correction in early 2016 hedge fund manager George Soros and others inspired speculators 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 and amplified the stock market fluctuation instead of smoothing it.
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, had a 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 are scavengers who want to benefit from the misfortune of others or even cause it. 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.
Unfortunately the Security and Exchange Commission (SEC) has a blind eye for short sellers and has been ignoring their manipulations over decades. No wonder, that Tesla CEO Elon Musk calls them Short-Seller-Enrichment-Commission.
Maybe the recent short squeeze delivers the short sellers the attention they deserve.
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