To be super clear, naked short selling is banned for everyone but market makers [1]. A market maker goes naked short when there is a buying frenzy. Their economic incentive is to then cover the short given they are in a buying frenzy.
The NYSE explicitly markets its specialist system to issuers as a stabiliser mechanism. It’s a selling point to long-term investors and Boards. The only people who get upset about this are hedge funds and day traders who get ahead of their skis.
[1] By Wall Street tradition, every long losing money must allege naked shorting. That doesn’t substitute for evidence of it. Large amounts of short interest do not indicate naked shorting. (Lots of FTDs do, but this figure has to be scaled to leverage and volatility.)
After all, we allow something similar to naked short selling when people write options or trade futures. And those markets work just fine.
My comment was meant to say that I think it would be fine to allow everyone to do naked short selling like that. Of course, subject to margin requirements etc.
The actual share gets delivered 2 days later, and it doesn't matter whether who you bought from, short-seller or otherwise.
Your voting rights are exactly the same.
You are right that replicated shares with options and other derivatives usually does not come with voting rights. That's true.
The market price for voting rights on individual shares is usually miniscule. But non-zero.
I wonder what the value of short term naked short selling would even be? In that timeframe borrowing should not be very costly anyway? The GME shorts have been short way longer than 2 days.
First, to put everyone on the same footing as the market makers.
Second, just to make short selling easier in general. Short sellers are massively important to spots bubbles and other asset mispricings, but they never get any love.
When someone buys a stock very often the purpose is to "physically" have it as soon as possible.
Though funny enough, stocks are already a virtual thing and exist in computers only. Whereas oil or onions are physical goods, and there are real consumer who absolutely need real physical onions.
What you are saying is like saying that lending money to your friend creates inflation by expanding the money supply, because you still have $10 (that he's holding for you), plus he also has $10. In fact, since he knows he owes you $10, he's going to have to cut back on his spending at some point in the future, to pay you back. (Your mileage may vary with actual friends.)
The key difference in your estimates of supply is that you include the future repayments of current lending, but ignore future lending. The general assumption in macroecomics is that we don't treat such lending as isolated one-off events, but as a sum of ongoing activity by many people, continuing forever at a stable level unless some event affects it.
Assuming that the principles governing lending don't change, the future repayments are balanced by payouts of new loans at that point of time, and the current payouts (if they are greater than current repayments of past debt, i.e. there's a net increase) are not balanced and thus increase the supply. If at some point the fundamentals change so that the lending decreases or stops then that event would decrease supply back to where it was.
I.e. if you often lend money to your friends so that usually someone or someone else owes you $10, then this lending is not a change and does not affect supply, but if you did not loan money and now you start lending, then that $10 is an increase in money supply.
You are talking about lending by banks, and/or the central bank, which is quite clearly money creation.
New lending of your money to your friend does not create additional money.
There's also a word game going on here. What you are describing is a situation where I lend money to my friend, and for the purpose of your analysis, you assume that I will always have lent out a similar amount of money forever starting now.
That's fine if that's what you want to analyse. But that isn't the situation I described.
Not if the company goes bankrupt though, right?
Seems like a potential strategy hedge funds can use (and maybe are using) is to short a company a ton and collect a lot of money from that. They can short more than the float, so even collecting more cash then the market cap of the company. This drives the price down, because there is more supply. The more they short, the more the price goes down. Then they just wait for the company to go bankrupt, which is more likely since the company's share price is in the dumpster.
See, eg, https://www.bloomberg.com/opinion/articles/2018-04-11/-go-to...
> Seems like a potential strategy hedge funds can use (and maybe are using)
Anyhow, no, doesn't work. Even apart from getting burnt when the fraud is finally exposed and the company goes bust before your short position is closed or whatever (which is thankfully pretty unusual), stock borrow costs will eat you alive. Also, you can't short more than the float (short interest can be over 100%, but that's confusing net versus gross), you can't collect more cash than the market cap of the company, and you can't really bankrupt healthy companies by shorting the stock.
(The way short sellers (like Muddy Waters work is they find a company doing a bunch of fraud, they take out a large short position, then they publicise their research. If the market agrees with them, the uncovered fraud tanks the stock price, and they make a healthy profit. Sometimes the company ends up bankrupt and/or with their executives in prison, but the cause is the fraud, not the short selling. Short selling an otherwise healthy company into bankruptcy doesn't make a lot of sense in theory, and doesn't seem to happen in practice.)
This is giving the market a lot of credit for being a rational and well-informed actor. The market is not full of people who calmly evaluate a short seller's argument and make a logical decision. It's full of people who lack the time, experience, and confidence to question the "financial expert" making dire predictions on the morning news and think "I should get out of this stock just to be safe".
But it's a question of scale. The fact that any one investor may make mistakes doesn't mean that the market as a whole, in the medium or long term, also makes these sorts of mistakes.
"Some hedge fund guy released a report saying stock X is bad and the stock tanked 30% from small investors panicking before recovering when people realised it actually wasn't bad" is pretty silly, yes. And it's a bit rough on the small investors selling at a loss into the large investors who are able to correctly analyse the report, absolutely. But does any company actually go bankrupt in cases like this? The answer seems to be no; there's no evidence for it happening, and it's hard to see how it even could. Confused retail investors can lead to price volatility, but they don't make or break a new share offering.
In practice you just don't see examples of productive companies driven into insolvency by short sellers.
There's no such reality check with things going up on the long side as we see from Gamestop. Someone can't step in and cash out on the company at a ridiculously high price compared to fundamentals. It is only driven by the market. In general short sellers are vilified more than warranted. If you are long on a good company you should applaud them because after all, they now have to buy back at some point. People view it as if you are some villain going against what is right (shares just going up and everyone gets rich). Stocks that go down with high short interest are almost always going down because they are bad companies, not due to short sales.
The price of something is just what someone else will pay. Period.
Intrinsic value factors into what people are willing to pay but only indirectly.
See: beanie babies, trading cards, status items, old land rovers.
No, it's the result of supply and demand not supply and “intrinsic value”. Demand is driven by subjective value, not “intrinsic value” which is a nonsense concept that misunderstands fundamentally how value and human action relate.
Tautologically so, in the sense that the market’s notional consensus of the expected future cash flow is inferred by those who are convinced of it's simplistic financial rationality from the stock price and assumptions of the proper discounting mechanism. Factually...that's a bit harder to argue.
There's some a-step-more distant proxies that people hold up as touchstones for that like P/E ratio, but those aren't consistent across stocks or, marketwide, over time.
short selling does not increase the number of shares. if i borrow a share from you and sell it, you cannot also sell that share. the number of shares is constant regardless of how many shares are sold short (except for naked short selling).
short selling increases the number of people that can sell, but that only increases symmetry in an otherwise asymmetrical system. anyone can bet that the price goes up, but without short selling, only people that already bought can bet that the price will go down.
> there's always going to be a perverse incentive to target any company so long as you can manipulate the supply enough to force a price drop
what is "manipulative" about selling a stock? if i buy a bunch of stock (to make the price go up), is that also "manipulation"?
I think some of the confusion is people talking past each other.
I think some people latch onto the whole concept of "borrowing" as the supply inflation. In the housing market, when I buy a house it is OFF the market. There is no "borrow someone's house & reintroduce it into the supply and gamble on the direction of the market".
Can you comment on how that interpretation is wrong?
The case outlined in the whitepaper is not just regular short-selling (e.g. you borrow a share and sell it, with a promise to buy it back). Short selling has actual uses in a market and they are not claiming that shorting in itself is "manipulative" or "fraud".
Their claims of counterfeiting stock involve the use of naked shorts(a.k.a where a share is sold, but never borrowed) Naked shorts must be attached to a real share within 3 - 21 days, not doing so is illegal. They outline a series of loopholes which are used to sell shorts w/o ever borrowing a real share, effectively diluting the actual stock issued by the company with extra counterfeits to drive the price down. The goal is to drive the price to 0 and bankrupt the company, so that the shorts don't have to be covered anymore, netting a large (tax-free) profit.
> if i buy a bunch of stock (to make the price go up), is that also "manipulation"?
No, lets talk about the details of how actual manipulation works. Below is not an exhaustive list of manipulation tactics, just a selection of examples:
1. SEC rules left a loophole allowing naked shorts to be covered with naked calls. No actual instance of stock has to actually be borrowed in this case, but it's not marked as a fail-to-deliver in SEC reporting. The naked call option is not tied to any stock issued by the company, it's just an option to buy at a future date, but it can now be repeatedly borrowed out for shorts as if it were a stock.
2. The SEC keeps track of fail-to-deliver in the SHO list and has requirements of 3 days for brokers and 21 days for market makers to borrow an actual stock. Another fraud claim is that brokers/hedge funds collude to pass around naked shorts between offshore shell companies in order to indefinitely reset the 3 day SEC requirement to keep naked shorts indefinitely and keep it off of the SECs fail-to-deliver list. They also use a similar technique to allow 8 - 10 shorts to borrow the same shares and then just move them around in time to meet SEC reporting deadlines. During any audit by the SEC, the SEC calls ahead and they move all naked shorts to offshore accounts where they can't be seen and then move them back once the investigation is over.
This means for every fail-to-deliver marked on the SECs books, there will be several times (10 - 20 according to the whitepaper) more counterfeit shares being sold by shorts that are not tied to any real shares.
3. The third fraud claim involves the clearing house (a.k.a a broker for brokers) the DTCC (we care about two of its subsidiaries DTC and NSCC). When a broker sells a short and fails to deliver an actual share in 3 days, before 1981 they would be forced to buy it back. After 1981, they can borrow one from the NSCC Stock borrow program. The NSCC will then go to the DTC which holds all the stock certificates and find a broker with a surplus of shares and borrow the necessary amount of shares.
Now here's the fraudulent part. When the shares are borrowed only the net amount is deducted from the surplus, but no actual shares are actually removed from the individual accounts of the broker. Now both the lending broker and the borrowing broker have real shares in their account, but they're the same real shares. Since the borrowing broker has real shares now, these same shares can again be lent out by NSCC to another borrowing broker and again no shares are removed. Now 3 investors have the same shares in their account. Since transactions are done as net transactions (instead of individual stocks) between brokers, the fact that 3 investors have the same share never has to be reconciled and two counterfeit shares have been created.
In regards to the GME short, even though only 71 million shares were issued by the company, currently institutions have reported to the SEC (13F filings https://fintel.io/so/us/gme) that they own more than 113 million shares (including 13% owned by gamestop ceo).
Additionally according to the SEC's fails-to-deliver list for December, Gamestop has nearly 1.8 million shares failed-to-deliver. Most companies have anywhere from 0 to a few thousand. Going by the whitepapers estimates the number of counterfeit shares would be 10-20 times that amount, indicating that ~ 40 million shares of Gamestop would be counterfeit.
In order to verify these accusations with concrete data, we would need access to the books/transactions of the DTCC. They are a private organization that is collectively owned by brokers and they are very secretive and have few disclosure requirements due to regulatory capture at the SEC.
An undervalued share price is also a great opportunity for the company (or anyone really) to buy back some of their stock. In that sense, by manipulating the price too low, the short sellers are basically giving the company an opportunity for easy money.
Also, why wouldn't you have to pay tax on gains from a short if the company goes bankrupt?
If a casino allows you to make play as long as you want, i.e. unlimited bets, does that de-value the bet?
If the shorted stock doesn't go down, people need to pony up the difference to buy it back; it is that capital risk that represents the "skin in the game", and why shorts aren't really unlimited, any less than an insurance company is limited in how much insurance it sells, by the capitol it holds to pay out on claims.
Short term trading has nothing to do with fundamental.
The market can be irrational.
No. The price of a stock is the value of its discounted cash flows.
Shorting creates synthetic shares, that guarantee the new longs an exactly replicated stream of cash flows. This doesn’t make the original shares any less valuable, because they still have the same cash flows.
Imagine someone conjured a new company, called Tesla-2, out of thin air. It’s future profits and dividends exactly match Tesla. Why should this make TSLA any less valuable?
If people are investing in TSLA for the company’s long term viability, the existence of TSLA-2 should be a good thing for holders of TSLA. Now they can buy even more. It’s only bad if people are buying TSLA as a speculative asset to flip to a greater fool. Which is why short selling is such an important mechanism to prevent speculative bubbles.[1]
[1] https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261....
In my naïve view, TSLA's future cash flows have value because the company is expected to sell a lot of cars that:
1. No one else makes (or practically no one, such that TSLA has a majority of market share)
2. Many people want to buy.
Now, supposing TSLA would be able to service all the demand for its cars, how would a competing TSLA-2, presumably offering identical cars (or of identical value at least) not affect TSLA's future cash flows?
All things equal, if two companies sell products that are basically the same (same quality, price, etc), wouldn't that split the market in two? I wouldn't expect to see people buying twice as many cars because there are now two companies producing them.
Nearly. There ARE a few other reasons to own a stock, such as the right to influence the governance of a company.
(I agree that shorting is an important market mechanism that protects against frauds and bubbles. I am much less sure that naked shorting provides value. In fact, I'm not sure I have ever heard an argument for why naked shorting is valuable... they always turn out to be arguments for why shorting is useful.)
Once the IOU comes due, B will need to acquire a share from D to give back to A, at which point both A and C own a share - but D no longer does.
At no point are there any magic duplicated shareholding rights.
And you don't get extra voting rights for shorting (borrowing) a share.
https://www.investopedia.com/ask/answers/05/shortsalevotingr...
The price of anything is a result of its some intrinsic value and the volume of supply. So a precious stone is valuable because of its beauty, but also because it's rare. If someone mines a billion such stones, it won't affect their individual beauty, but it will certainly reduce the price someone is willing to pay for one.
Now, you seem to be saying that short selling is a signal about intrinsic value, but the process you describe, whether you want to call it counterfeit shares or fractional reserve shareholding or whatever also messes with the valuation by inflating the supply. If there are more shares of a given company available, those individual shares will be worth less.
The result would seem to be that naked short selling at volume will create a self-fulfilling prophecy. You can drive the price down simply by inflating the supply, regardless of whether the company is well managed or not. Maybe you start with badly-managed companies, but there's always going to be a perverse incentive to target any company so long as you can manipulate the supply enough to force a price drop. If you care about the market as a measure of company health, that doesn't sound like a good idea.