Economics: The Case Against Short Sellers

  (Drivebycuriosity) - There is a controversy about short sellers, speculators who are betting on falling prices of stocks or other assets. They borrow stocks and sell them immediately in the hope to buy them back later for a much lower prices. Short sellers are popular in the media. "Every stock market party needs a short seller", claimed Bloomberg (bloomberg). The Washington Post defends short sellers and claims that they "link stock prices to fair value" (washingtonpost ) and "The New Yorker", also on the left side of the political spectrum, headlined "In Praise of Short Sellers" (newyorker.com ). 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).

I doubt that short sellers deserve the praise. They don`t invest, they don´t support economic growth and rising standards of living. They are not interested in the success of companies, quite the opposite, their business model is based on - real or alleged - failure of others.  

Hedge funds like Muddy Waters and Citron Research usually short certain stocks and then they you use social media to spread rumors & fake news. Short sellers often appear on CBNC & Bloomberg TV and they use Twitter and the portal "Seeking Alpha" to talk prices down. These shortsellers intend to be a "catalyst" and to start a negative stock price moves which picks up momentum on its on and becomes a snowball ( institutionalinvestor). 

All short sellers benefit from falling stock prices. Thus they have a natural interest that the business of the shorted company fails. Short sellers are scavengers who want to benefit from the misfortune of others or even cause it. 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. In 2018 a short seller, named Rota Fortunae, attacked the real estate investment trust Farmland Partners Inc. (FPI ) and claimed the stock was “uninvestible”, which drove the stock price close to zero ( reuters). The stock needed around 2 years to recover from the attack (chart below).

(cnbc )

The tactics of short sellers inspired the producers of the James Bond movie "Casino Royale": There 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. Just fiction? Not really. In 2017 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. And a short seller of Tesla stocks caused crashes with Teslas to send the stock price south (ccn ).

Feral Hogs

In the recession of 2008  short selling was a viable business model. Hedge funds and other speculators were betting on a meltdown of the stock market and were shorting it. Massive shorting accelerated the fall of the stock market which intensified the pessimistic sentiment and inspired so more short selling, creating a snowball effect. The negative bets 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, by massive selling and spreading gloomy rumors.  Dallas Fed President Richard Fisher, member of Federal Reserve, 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).

Late 2008 the massive bets against banks and many other companies - supported by spreading gloomy rumors all over the media - destroyed not only the trust into the attacked firms, the negative 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 - partly caused by short sellers - lead to a 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. 

Similar collective bear reads repeated in the following years. 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. Short sellers also made the march 2020 stock plunge worse.

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. 

Stock sellers harm the whole economy and slow down economic growth because 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 short sellers are not regulated the way Wall Street analysts or fund mangers are, so they aren’t as accountable (bloomberg ). 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. Short-sellers in the U.S. are protected by the First Amendment, which gives them broad discretion to offer their view on a company as long as it is stated as an opinion they believe to be true (institutionalinvestor ). Freedom to manipulate, to harass and to ruin others?