Shakespeare was wrong: First, we should target the short sellers …
“The first thing we do,” Shakespeare wrote for one of his characters in Henry VI, “we must kill all the lawyers.”
Naturally, I don’t share his sentiment, but if anything needs killing right now in order to stop the global financial crisis, it is the act of short selling.
Bloomberg reports that certain major US pension funds have nipped some short selling in the bud by refusing to allow shares to be used for that purpose:
“Wachovia Corp. soared 59 percent, Citigroup Inc. added 19 percent and Bank of America Corp. jumped 12 percent, sending the KBW Bank Index to its biggest gain since July. Morgan Stanley erased a 46 percent tumble and Goldman Sachs Group Inc. recovered most of a 25 percent slide after the nation's three largest pension funds stopped loaning shares of the brokerages to investors betting on their declines.”
http://www.bloomberg.com/apps/news?pid=20601087&sid=a5SOK1vsQl50&refer=worldwide
That’s the best financial years in the past month. When the next president gets round to finding out what went wrong and how to fix it, I would expect the almost unlimited pillaging which short sellers have been allowed to do will rank high amongst the list of culprits.
As one short seller put it:
“``Short sellers are a very important part of the ecosystem of our financial markets,'' said Angel, a professor at Georgetown's McDonough School of Business in Washington. ``The same way that lions go after a herd, they go after the weaker animals. The shorts will pick on a company where there's a legitimate controversy over its valuation.''”
http://www.bloomberg.com/apps/news?pid=20601087&sid=abz3Png6wvrM&refer=home
Of course, that is self-justification. Short sellers have plundered the currencies of countries, wreaking havoc; many were Americans. It is almost poetic justice that short selling has caused so much harm to so many American investors these past few weeks; talk about the boomerang effect!
Let's start at the beginning (what is short selling), and then look at what short sellers have been doing in the past few months.
Wikipedia has a good article on short selling – it has a long history:
“Short selling has been a target of ire since at least the eighteenth century when England banned it outright. It was perceived as a magnifying effect in the violent downturn in the Dutch tulip market in the seventeenth century.
The term "short" was in use from at least the mid-nineteenth century. It is commonly understood that "short" is used because the short seller is in a deficit position with his brokerage house.
Short sellers were blamed for the Wall Street Crash of 1929.[citation needed] Regulations governing short selling were implemented in the United States in 1929 and in 1940. Political fallout from the 1929 crash led Congress to enact a law banning short sellers from selling shares during a downtick; this was known as the uptick rule, and was in effect until 2007. President Herbert Hoover condemned short sellers and even J. Edgar Hoover said he would investigate short sellers for their role in prolonging the Depression. Legislation introduced in 1940 banned mutual funds from short selling (this law was lifted in 1997). A few years later, in 1949, Alfred Winslow Jones founded a fund (that was unregulated) that bought stocks while selling other stocks short, hence hedging some of the market risk, and the hedge fund was born.[3]
Some typical examples of mass short-selling activity are during "bubbles", such as the Dot-com bubble.[citation needed] At such periods, short-sellers sell hoping for a market correction.”
http://en.wikipedia.org/wiki/Short_selling
But what exactly is short selling? Again fromWikipedia:
“To profit from the stock price going down, short sellers can borrow a security and sell it, expecting that it will decrease in value so that they can buy it back at a lower price and keep the difference. The short seller owes their broker, who usually in turn has borrowed the shares from some other investor who is holding his shares long; the broker itself seldom actually purchases the shares to lend to the short seller.[1] The lender of the shares does not lose the right to sell the shares.
Short selling is the opposite of "going long." The short seller takes a fundamentally negative, or "bearish" stance, anticipating that the price of the shorted stock will fall (not rise as in long buying), and it will be possible to buy at a lower price whatever was sold, thereby making a profit ("selling high and buying low," to reverse the adage). The act of buying back the shares which were sold short is called 'covering the short'. Day traders and hedge funds often use short selling to allow them to profit on trading in stocks which they believe are overvalued, just as traditional long investors attempt to profit on stocks which are undervalued by buying those stocks.
In the U.S., in order to sell stocks short, the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. This is referred to as a "locate," and it is a legal requirement that U.S. regulated broker-dealers not permit their customers to short securities without first obtaining a locate. Brokers have a variety of means to borrow stocks in order to facilitate locates and make good delivery of the shorted security.”
How much short selling has been going on lately?
Lots. Bloomberg:
“More than $1.4 trillion of equities worldwide are now on loan, about a third higher than at the start of 2007, data compiled by Spitalfields Advisors, the London-based firm specializing in securities lending, show. Almost all of that is being used to speculate that shares will fall, according to James Angel, a finance professor at Georgetown University who studies short selling. The global economic slowdown, $453 billion in bank losses and an explosion of funds that can profit from stock declines spurred the increase in short selling, helping send 22 of 23 countries in the MSCI World Index into bear markets.”
Let’s see whether US regulators agree with (my amended) Shakespeare…
