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Don't Blame the Shorts: A History of Misplaced Aggression

Posted Nov 25, 2009 07:30am EST by Heesun Wee in Investing, Commodities, Recession, Banking

As the stock market continues its winning streak from March levels, cries against the evil speculators and short sellers have subsided -- for now. If any cracks in the recovery story emerge, beware of attacks against short sellers, says Robert Sloan, managing partner at S3 Partners. The firm offers outside financing for hedge funds and manages about $53 billion in assets.

Blaming shorts during bad financial markets is "a convenient way to take a very complex problem and isolate it," says Sloan, author of a new book, Don't Blame the Shorts: Why Short Sellers Are Always Blamed for Market Crashes and How History Is Repeating Itself. "It becomes very easy to encapsulate all our ills into one financial instrument and it just so happens that since the Depression it has been short selling that's been the repository of that blame."

Part finance book, part history lesson, "Don't Blame the Shorts" offers historical perspective on the controversial trading practice, and shows how America's distaste for speculators dates back to the Founding Fathers. (In short selling, investors sell securities or futures they don't own, but hope to buy back later at lower prices.)

During the 1930s, for example, names of short sellers were listed in newspapers. "Vote Wide Inquiry on Short Selling," read a headline in The New York Times in March 1932.

At the time, the Missouri Kansas Pipe Line Company raised accusations of a bear raid on its stock, just as many Wall Street CEOs blamed short sellers during the crisis in 2008.

Yes, history tends to repeat itself, and Sloan argues muzzling short selling could have unintended consequences. "If you take away short selling you're taking away capital creation," Sloan says, estimating short sellers provide as much as $500 billion of liquidity to markets like convertible bond, preferred equity, and distressed debt and high-yield bonds.

Short sellers also serve as "the police agent in the marketplace," he says, going undercover to ferret out bad business models if not outright fraud. In this view, when short sellers like Jim Chanos and David Einhorn point out flaws in firms like Enron and Lehman, respectively, they're doing investors a favor rather than seeking to profit from others' misery.

117 Comments

drchemp
drchemp - Wednesday November 25, 2009 07:35AM EST

I have no problem with shorts. This is a critical component of market making to determine the fair equilibrium pricing. However, naked shorting is counterfeiting (just like the Fed printing money) and this and only this I have a major problem with.

Johnny
Johnny - Wednesday November 25, 2009 07:37AM EST

It is illegal and unfair..........to be honest I like it to be abolish......Is anybody agree or dis-agree? you are free to cast and stone me if I was wrong.......

Jan
Jan - Wednesday November 25, 2009 07:43AM EST

Shorting allows an investor to cover any potential loss in the market. It is just as much a means of investment as buying a long position. Right now with all the horrific economic news, shorting is necessary. Comanies are making about twenty percent of what they used to make in earnings. If a stock was selling for forty times earnings would you short it or go long? Normal price to earnings should be under ten.

Jan
Jan - Wednesday November 25, 2009 07:48AM EST

I have been guilty of "naked longing" all of my investing life. I never have physical possession of stock shares that I have bought. If that is not wrong, then what is wrong with naked shorting?

TikAro
TikAro - Wednesday November 25, 2009 07:51AM EST

Naked shorting is preposterous. No one should be allowed to sell something someone else owns.

chistletoe
chistletoe - Wednesday November 25, 2009 08:09AM EST

These days shorting stocks is not the issue. These days there are many in the market (including me!) who are in effect shorting the US Government, by buying gold. If anyone believes that the US government is honest, trustworthy, and has every intention of repaying its debt, then please -- buy US Treasury debt and sell gold short. I have no power to change anything through peaceful means ... sooner or later, the power always passes to the worst people, and the reasonable people cannot stop this process. All I can do is strive to protect my friends and family when the worst comes to pass -- and it surely will .... Otherwise, shut up ...

chistletoe
chistletoe - Wednesday November 25, 2009 08:12AM EST

These days shorting stocks is not the issue. These days there are many in the market (including me!) who are in effect shorting the US Government, by buying gold. If anyone believes that the US government is honest, trustworthy, and has every intention of repaying its debt, then please -- buy US Treasury debt and sell gold short. I have no power to change anything through peaceful means ... sooner or later, the power always passes to the worst people, and the reasonable people cannot stop this process. All I can do is strive to protect my friends and family when the worst comes to pass -- and it surely will .... Otherwise, shut up ...

gollywogazoo
gollywogazoo - Wednesday November 25, 2009 08:13AM EST

the problem with short sellers is they can kill off a wounded company, that, given time, may have been able to heal itself. Yes, short sellers may discover bad apples that should indeed be purged from the market place, however when massive & systematic "bear raids" are allowed to occur (as what happens in "naked" short selling), no one's interests are served - except those of the fraudsters taking part.

CiGi
CiGi - Wednesday November 25, 2009 08:15AM EST

Don't short.. just withdraw all your $$ from the banks this Christmas and see how Wall Street and the administration crawl... The only way to punish Wall Street and the administration is to withdraw all your money !!!

william
william - Wednesday November 25, 2009 08:16AM EST

short selling is part of the game... best left for the professional speculators... in the meantime, go long and jump on the train... those of you watching the train roll by.... see ya... choooo choooo

Robert
Robert - Wednesday November 25, 2009 08:18AM EST

you can take solice in the fact that us shorts have been getting creamed the last few months. You should be more mad at the pump and dump players that suck you into buying while they are selling and companies that report manipulated information. I'm upset at how the Gvmnt has conned you longs into the fact that "BAD" IS the new GREAT. The FED is pumping up this market so that the GVMNT can get some tax dollars on stock profits. That will all change come Jan 1. Good luck to everyones 401K when reality sets in.

Rey
Rey - Wednesday November 25, 2009 08:23AM EST

Shrts ----- Longs // This Market is just about ready to plunge again

Yahoo! Finance User
Yahoo! Finance User - Wednesday November 25, 2009 08:25AM EST

I really could give a flying damn what anybody invests in, provided that I dont share in the losing of their ass when the time comes. Conversely, I feel no entitlement to any of the upside either.

Oso Velo
Oso Velo - Wednesday November 25, 2009 08:28AM EST

I say ban options that allow speculation to the positive side- i.e. buying and selling calls. Everyone's in agreement that repeated bubbles have a disastrous long-term effect on the economy and those bubbles aren't caused by speculation on the short side- they're caused by one fool after another going long in the face of weak fundamentals. Seriously, if trading in options is banned at all, the money will find other ways of manifesting itself- e.g. going "offshore".

LegalizeMe
LegalizeMe - Wednesday November 25, 2009 08:43AM EST

I can pay for health care and encourage world peace at the same time. Legalize marijuana and tax it. We all know the US produces the BEST weed in the world despite being illegal, imagine what we could do if it wasn't!

Joe
Joe - Wednesday November 25, 2009 08:46AM EST

Naked shorting is the problem. Selling or buying short has never been the problem, so long as there is stock to cover the transaction. The best example of the problem is the oil market. Once again. naked shorting of oli futures has created a false oil market and driven fuel costs to extraordinary highs in order to satisfy the financial engineers. This must be stopped or else another bubble will be created and burst.

Yahoo! Finance User
Yahoo! Finance User - Wednesday November 25, 2009 08:50AM EST

The process of "shorting" has acquired bad connotations at various points during trading history. Of course there was no criticism of short sellers during the bull market period from 2002-2007. Short stock market sellers provide a mechanism to identify specific activity in a company that does not justify its stock price. Short selling, by the way, is a very integral part of the futures markets. To learn how to position your investments in the current and coming market climate visit http://www.TheSentinel.biz

Yahoo! Finance User
Yahoo! Finance User - Wednesday November 25, 2009 08:52AM EST

However, naked shorting is counterfeiting (just like the Fed printing money) and this and only this I have a major problem with. In that case, selling wheat futures and oil futures is also counterfeiting wheat and oil. There's no difference between selling "located" shares and naked shorting. I've never met a person who rails against naked shorting who actually understands anything at all about capital markets. That never stops them from leaving their mental droppings, of course.

william
william - Wednesday November 25, 2009 08:56AM EST

.. the train is getting ready to leave the station... it's going to be a good ride.. make sure to get off before Thanksgiving... chooo choooooo

Jan
Jan - Wednesday November 25, 2009 08:56AM EST

ADJUSTED DATA FOR UI CLAIMS (Falsified Data) In the week ending Nov. 21, the advance figure for seasonally adjusted initial claims was 466,000, a decrease of 35,000 from the previous week UNADJUSTED DATA The advance number of actual initial claims under state programs, unadjusted, totaled 543,926 in the week ending Nov. 21, an increase of 68,080 from the previous week. ^^^^^^^^^^^^^^^^^^^^ Now that they are claiming another decrease I wonder if they can get the market to rally some more? Does anybody pay attention to reality? As I have said before there is no reason to alter the actual numbers into the lies that they make up. There is no season for UI claims, just reality of people out of work filing for their insurance that they paid for. Saying that you can seasonally adjust that number is just like saying you can seasonally adjust the number of people who have died recently because they should not have died at this time. They did die and it is a reality. There is no justification for lying about it. Did you also note the collapse in Durable Goods orders???? The Titanic is going under.

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