An ode to short-sellers
“He who sells what isn’t his’n, must buy it back or go to pris’n.”
A short seller avant la lettre
The above quote is from Daniel Drew, a businessman active in shipping and railways in the 19th century at the time of raw American capitalism. Later, he became a speculator in shares. Initially, he was very successful, partly by going short on shares of his major opponent Cornelius Vanderbilt. A crash in railway shares – the technology funds of the day – left him penniless. He died in 1879, completely dependent financially on his son. The most notorious short seller in modern history, however, was the renowned Jesse Livermore. As a 14-year-old boy, he ran away from home to gamble on stock prices. He turned out to be a very successful investor. His biggest “number” was his heavy speculation on a fall in the US stock market in 1929. The infamous crash of 1929 – the market would eventually lose as much as 90 percent of its value – made him very rich. And very hated.
Speculating on a fall in share prices is centuries old and has always been controversial. The fuss about the American chain’s shares in video game shops GameStop is, in that sense, nothing new under the sun. Several hedge funds had speculated on a fall in GameStop’s share price. Given the ongoing digitalisation of video games and the hopeless situation in which the obsolete GameStop had ended up, this was not so strange. Millions of private investors, encouraged by messages on the Reddit forum, bought shares against which they had taken substantial short positions. The professional investors then saw the prices rise sharply and had to quickly buy back the shares they had previously sold with borrowed money in order to limit their losses. The “attack on Wall Street” was celebrated by the individuals, who saw themselves as heroes. “The perverse stock market system, in which money-hungry funds had become rich by speculating on falling stock prices,” had been crushed.
Speculating on a fall in prices is seen by many as unethical. Investors would profit from the misery of others. For example, George Soros made billions from the crash of the British pound and John Paulson became very rich by going short on US mortgage bonds. Just like Michael Burry, the main character in the film The Big Short. Short selling would push listed companies, already in trouble, even further into the abyss. During the last financial crisis – the 2008-2009 credit crunch – regulators in Belgium, France, Greece, and Spain banned short selling. Short sellers were said to think only of their own profits and to have no regard for the interests of shareholders, let alone employees and suppliers of the companies whose shares they were shorting.
The world’s richest man, the CEO of Tesla, also recently made a comment. “You can’t sell houses you don’t own, you can’t sell cars you don’t own, but you can sell the stock you don’t own? This is bullshit – shorting is a scam, legal only for vestigial reasons”. But is this criticism justified? Is it not true that the whole economy revolves around trading in things we do not own? We buy houses with borrowed money, sell them at a higher price, and pocket the profit. When investors at Robinhood buy shares with borrowed money – on margin – and sell them later at a profit, they are doing little else. Short selling actually contributes to market efficiency. It makes the true value of an investment much clearer and quicker. For example, the German regulator banned short selling in the shares of Wirecard. Hedge funds were alleged to have colluded with journalists to push down the price with lies about fraud. Unfortunately, they were not lies.
Speculating on a fall in share price provides more liquidity in the market. It makes investors realise that the financial situation of a company may not be as rosy as it first appears and that a share price may have drifted very far from its intrinsic value. More importantly, an investor who borrows shares to sell them in order to buy them back later at a lower price effectively puts a floor under the market. The first buyers of stock, after a devastating fall, are often not daredevils who see the sun rising again in the distance, but short-sellers taking profits on their positions. A ban on short selling, therefore, is nothing more than the tearing down of a protective wall around the stock market.
An ode to short-sellers
Short-sellers may not be very popular, but banning speculation on price falls does not seem the most desirable solution. “Short sellers are like predators of the Savannah. They eliminate the weakest animals from the herds. And they create more liquidity in the market. They fulfill a useful role”, according to trader Richard Corvenius on IEX Profs. Therefore, herewith an ode to the short-sellers.