Shooting The Messenger

NEW YORK - SEPTEMBER 19:  A man walks across t...Image by Getty Images via Daylife

I’ve been uncomfortable with the "no shorting" rules that the gov’t put in place thursday night. I couldn’t really articulate my discomfort with them, but my buddies Howard and Roger have done it for me.

Howard wrote

I will have to adapt just like everyone else, but my initial feeling is
‘FUCK IT’, the market just put me out of business for a while. Our
leaders have spent the last few months printing money, and catering to
the thieves in the financial industry, while punishing the group of
investors whose job it is to shed early light on areas of financial
crimes. It’s sickening, but I am not getting into that conversation or
mess. It’s good for traffic, but bad for my bottom line and YOURS.

Roger said

It is very easy to dislike shorts. They profit if things go badly, and
we in this country are an optimistic lot. It seems practically
un-American to be shorting stocks, profiting at someone else’s expense.
The problem is, both ordinary citizens and those in Washington simply
don’t get it. Short-sellers keep companies honest. How many recent
examples have we seen of companies being economical with the truth in
order to prop up their stock prices and fatten the wallets of those in
the executive suite (see FNM, FRE and AIG, for starters)? It is the
shorts who sniff this out and make other investors aware in order that
they can re-calibrate their expectations, and to perhaps sell before it
is too late. This is how Enron was busted, with one of the catalysts
being that now-famous conference call when Jeff Skilling went
stark-raving mad on one of the Managing Partners at Highfields Capital
who had factually cornered him.

It’s clear that in the past month or two we’ve seen the short sellers taking on the brokerage firms here in the US the way that Soros took on the British Pound in 1992. Like Soros, the short sellers saw weakness and pounced on it. And they weren’t going to stop until they’d taken every shot that looked like a good bet.

The gov’t put an end to that trade with the ban on short selling and probably saved Morgan Stanley and possibly even Goldman Sachs from having to find a white knight to save them.

But was that a good idea? I have my doubts. As Roger points out, short sellers are using their capital to make a point, to show that something is a house of cards and it will fall if you blow hard enough on it. And they get paid handsomely to do that. As Howard points out, the brokerage firms have survived to live another day and the short sellers have been told to take their ball and go home.

We’ve shot the messenger who showed us that the brokers were playing too dangerous a game with too much leverage, a mismatch in duration between their assets and their liabilities, and balance sheets that are impossible to evaluate. So at a minimum, we’d better force the surviving brokers to fix those problems quickly with the threat that we are going to let the shorts back at them soon. Without a forcing function, nothing happens. And in this market, the shorts were the forcing function because our gov’t wasn’t paying attention.

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Comments (Archived):

  1. AndyFinkle

    Shorts had nothing to do with the recent claps of the financials. The facts just do not back it up. If you look at recent short interest stats., one will find that during this entire debacle short interest of the stocks within the Investment Banking index actually decreased from close to 10% down to almost 7%. More importantly, what’s good for the goose should be good for the gander. Why change the rules for a select number/type of stock only??It is easy to blame the shorts…no different from blaming the oil companies for making more profit when oil is high. People should NOT take their eye off the real ball (as it relates to the recent $1 Trillion bailout). The bigger picture is that there is over $60 TRILLION worldwide in CDS derivatives, and an eye whopping $600 TRILLION in financial derivatives in total. The world economy is one big ponzi scheme, and there is an issue with putting your finger in the dyke and plugging one whole. Someone smarter than I once said “For every action, there is an equal reaction…”. The Government should be real careful with this house of cards. Make no mistake, this was not caused by short sellers. It was caused by decades of deficit spending by consumers, businesses, and governments…and it aint gonna end

    1. gregorylent

      “The world economy is one big ponzi scheme, and there is an issue with putting your finger in the dyke and plugging one hole” …not sure if a professional financial/trader/banker would admit to the ponzi scheme meme, but for me it is pretty accurate …and it is all still being played quite lightly by anyone who deals with more money than he needs for groceries …i wish just one guy would have the guts to stand up and say “i was wrong” … it is a great tool for getting out from under the negative influences of denial ….. and despite today’s headlines, denial continues … that cures nothing ….

  2. howardlindzon

    right on andrew

  3. wood83

    Fred, nice to see Zemanta in action although it sure would be nice to see it reference blarticles with a bit more panache than the very factual, but not interpretive stuff from major news outlets.Ahem, for example:….

    1. fredwilson

      I felt the same way when looking for links this morningI think their social feature that was just added this week should helpMake sure you add your feed asap

  4. infoarbitrage

    Thanks, Fred, for using your platform to spread the voice of reason. Recent events are truly distressing and unbelievable.Rog

  5. kidmercury

    all the more reason to take your short bets to the forex market, the land where govt intervention is not nearly as bad, you do have the quasi-governmental, wholly undemocratic fed propping up the USD but you can even profit off that. and of course the commodities/metals market, bulls will be safe there.though i kinda sorta agree with the need to be wary of shorts. most trading volume is system trading/technical trading, those people (myself included) don’t care about finding the right price or honesty or any of that type of stuff, we are just looking for momentum. it can largely be a self-fulfilling prophecy, much like how bubble markets send prices through the roof — not because of a genuine belief the fundamentals warrant prices to be that high, but out of knowledge that demand can be manipulated around certain price points, and orders can be triggered if the market is pushed through those price points. bear stearns is a classic example, that company was essentially financially assassinated. the fact that speculative psychology rather than underlying fundamentals is dictating market prices is a real issue, as evidenced by speculators being partially responsible for oil price manipulation we saw earlier this year. this is yet another reason why companies should be wary of going public, as public markets in their current incarnation are based more on market psychology than on the merits of the company.ultimately though this problem, and all other economic problems, stem from the fact that the money supply has been WAY overexpanded, which is enabling all this speculative cash and creating all these synthetic instruments, unprecedented trading volume, malinvestments, inflation, and pretty much every other problem we’re facing. fixing monetary policy is the only real solution.but thanks fred for sticking up for messengers, as a messenger myself i deeply appreciate it.

  6. Dan Wulff

    David Einhorn of Greenlight Capital has been the canary in the coalmine for the recent crisis. He’s a great argument for why the ban on short seling is a bad idea. He shorted Bear and Lehman and made these positions public. This profile of him from a few months back is well worth reading:

  7. stone

    The government needs to get a handle on things. Wednesday was a very bad day for capitalism and Wall Street. I am anxious to see what happens after the dust settles. My guess is that people will go to prison and massive fines will be levied, but that won’t fix the underlying problems. Wall Street needs a major overhaul if it is to continue on in its current form. The American people have to be sick and tired of this nonsense. I know that I am.

  8. Steven Kane

    agree (and again, welcome back to the “far center”)the easiest way to understand this point is, imagine if the government stepped in to limit long trades.that is, imagine if the government decided to regulate how *high* a stock or index or position can go.hmmm, google’s at 600 and gaining 50 basis points a day? better freeze long trades to protect all those poor SOBs who have been shorting?i know, the government is at core trying to restore stability and confidence, and in the short run its hard to argue against that when we have a ride like we’ve had. but in the long run, changing the rules mid-game can not really be healthy

  9. Brian Dunbar

    If i can ask for an analogy – is this like the Federal Government saving the Big 3 automakers in the 70s by forbidding people from buying economy cars?

  10. denver_vegan_diner

    how do shorts help a market become more efficient when many of the people trading them never actually borrowed the shares in the first place resulting in tremendous downward pressure on share price that would not be there otherwise? I know the SEC reinstated its ban on naked short selling earlier this week as well, but how could that possibly be policed? the system just seems so complex and opaque that at this point, a temporary ban on short selling is the only policy action that could be taken to give both regulators and companies still standing the time to sort things out. Regardless of the ban and the current gov’t actions, more banks will go out of business, but hopefully it will be ones that really deserve to (WAMU) rather than ones that have been well managed relative to their peers and still provide a high degree of value (goldman)

  11. William Woody

    It appears the short selling rule expires October 2nd and is only on a subset of banks and banking firms, so it’s not like there is a permanent rule (or even a long-term rule) nor is it universal. (Source)

  12. Druce

    channeling keynes… in the long run we’re all dead… markets can remain irrational longer than the banking system can remain solvent … and then what?whether or not the shorts had anything to do with creating the mess (they did not), at this point it would be child’s play for anyone with a few billion dollars to bid up the CDS on Morgan Stanley, short the stock and make failure a self-fulfilling prophecy and make a killing in the process. and there’s no reason it would stop at Morgan Stanley or GS or Citi or JP I’m kind of split between thinking you have the Wall Street folks like Paulson manipulating the market and bailing out their own… and thinking they wouldn’t have done something so obviously against the whole notion of financial capitalism, unless they really believed, as they told Congress, that the alternative was that the dominos wouldn’t stop falling until there were none left standing.I’ll give Paulson the benefit of the doubt…discomfort with the orthodoxy of changing the rules in the middle of the game is probably dwelling on the itch of frostbite when you should be worrying about losing the limb to gangrene.

    1. Druce

      it’s cool that disqus let’s you go back and read previous comments… am liking that call to sell GS @165, buy GE @27 a couple of months back </patselfonback> . today’s call is GLD @85 </glimpseofobvious>

  13. Stefano Buliani

    Completely agree!A ban on short selling will simply create a artificial stability without solving the underlying issues.Propping up a crumbling building with wooden buttresses will hold only for so long. Something has got to give.Posted my thoughts on it yesterday – http://thebigdeal.wordpress

  14. Dave R

    I read Asencio’s book “Sold Short” and it really opened my eyes to the essential role of shorts in the market in beating out the fluff and outright scams. He has chapter after chapter of outright scams perpetrated against investors while the SEC did nothing to shut them down. It wasn’t until the shorts got involved and and revealed the scams that the public found out about the scams. It is not an easy job being a short – lot quicker to get wiped out on the short side if you don’t have the facts on your side. I’d say the problem is not enough shorts in the market – who would have warned us sooner about these over leveraged houses of cards on Wall Street.

  15. Kevin

    If shorts were being used in the traditional sense, then yes, shorts return markets to efficiency expediently. But when more and more traders develop shorting as a major tool, the true value of the company no longer factors into their actions. Instead, they pounce on any rumor to drive down stock prices, knowing that other shorters will do the same, and it is in all their best interest to continue driving the stock down. When I, who have never shorted before, consider shorting the moment a whiff of bad news hits a company as a trading strategy, I know that shorting no longer represents a tool to bring efficiency to the markets.This is especially true as traders follow the old adage, “Never try to catch a falling knife.”

    1. Christian Cadeo

      I think the main problem is that we had bunch of hedgies front-run their short position by putting unfounded rumors in the marketplace about pulling their prime brokerage business. This kind of shorting is pure market manipulation and no question had to be banned. The difficulty is isolating this kind of practice without banning shorting in general. IMHO shorting is absolutely critical to have an efficient market that allows irrational exuberance to be popped.

  16. rdeichert

    I agree that the new rules go in the face of our free markets, but I do believe there was probably widespread abuse. Naked shorting can’t be good and it’s hard to police. Can’t puts be used in their place?

  17. Guest

    Remember what Donald Rumsfield said about Abu-Ghraib? “The problem is that people found out about it.” Same with shorts. The problem is not the bad books of banks. It’s that some people know about them…

  18. pfreet

    Buying a stock and selling a stock you don’t own are not “equivalent but opposite” things. Some here have suggested it is.I am not a quant, so forgive my naiveté here. But, don’t put options allow you to profit from a stock price dropping? Why are shorts needed when options trading accomplishes the same thing without trashing the underlying equity in the process?

  19. Rian

    Quite right, Fred. They’re removing valuable information from the marketplace that helps the market operate efficiently.Unfortunately it’s a political move, and nothing more. A knee-jerk reaction by a bunch of pandering, ham-fisted clowns.

  20. kip

    If I can’t short, can I just buy puts and sell calls against the various firms. Does this really solve anything? And what about existing positions?

  21. Banet

    Roger said:<<<it is=”” very=”” easy=”” to=”” dislike=”” shorts.=”” they=”” profit=”” if=”” things=”” go=”” badly,=”” and=”” we=”” in=”” this=”” country=”” are=”” an=”” optimistic=”” lot.=”” it=”” seems=”” practically=”” un-american=”” to=”” be=”” shorting=”” stocks,=”” profiting=”” at=”” someone=”” else’s=”” expense.=””>>>I disagree. I think shorting a stock can be, in fact, an optimistic act. I don’t short a stock because I think a company is about to crumble — looking for such companies is too depressing. I look for companies that are doing well and then I think about who they’re taking their business from. By going long on the first and short on the second I double-down and cut down on the risk.Simple example: I’m not betting that Dell will fail as much as doubling down on my bet that Apple will thrive. :)Peterhttp://www.FlashlightWorthy…Recommending books so good, they’ll keep you up past your bedtime. 😉

  22. tcpeter

    I don’t know that I agree with the decision to ban short-selling, but making shorts out to be the end-all, be-all ethical watchdogs, solely “…because our gov’t wasn’t paying attention,” is more than a bit disingenuous. Don’t forget, shorts profit when these companies’ stocks struggle. The shorts may be right that companies’ balance sheets reflect a house of cards, hence their willingness to gamble the rest of the market will find out. And those actions may represent a balancing influence to public markets. But shorts do this to achieve profits – not to regulate the markets – just like value investors purchase securities whose balance sheets reflect greater value than the market price suggests. Of course shorts hope the market finds out. If it doesn’t, the short has nothing to gain. But there are easier ways to let the market know than betting against the stock.