First They Came For the Short Sellers

In Germany, they came first for the Communists, And I didn’t speak up because I wasn’t a Communist; And then they came for the trade unionists, And I didn’t speak up because I wasn’t a trade unionist; And then they came for the Jews, And I didn’t speak up because I wasn’t a Jew; And then . . . they came for me . . . And by that time there was no one left to speak up.—Martin Niemöller

Any educated individual should understand the essential role that short sellers play in a market economy. Of course, most don’t; and government and its mouthpieces are only too eager to exploit this deficiency in Americans’ education.

William Buckley used to say that he would rather be governed by the first 100 names in the Boston phone directory than by the entire faculty of Harvard University. Well, I don’t wish to be governed by either. Anyone who would believe this “short sellers are to blame” nonsense is not fit to govern; and yes, sadly, the public seems to be eating up this pabulum.

Anyone fit to lead would not be looking for a scapegoat. They would explain with clarity the real truth of how we got into this mess and the sound policies that would lead us out of it. That our leaders are spouting nonsense and the public is buying, says much about where we currently are as a nation—such a search for false, external villains is more worthy of a developing country where ignorance, fear, and superstition are the norm. Recently, in Pakistan—not exactly a bastion of stability and freedom—short sellers were blamed for their stock market bust.

Blaming short sellers is sort of like going to get a root canal and blaming your endodontist for the pain that you are going through. The short seller, just like the endodontist, is simply uncovering—not causing—the preexisting rot.

About the draft Treasury bailout bill that is currently before Congress, Joshua Rosner, a managing director at Graham Fisher (a company that does independent research for institutional investors) was quoted in The New York Times as saying that the bill:

prevents judicial review that could allow the protection of decisions that create false marks, hide prior marks, or could be used to prevent civil or criminal prosecution in situations where a management knowingly provided false marks that aided the growth of this crisis of confidence.

A “false mark” is “using mark-to-market accounting to hide the true value of security, rather than disclose it honestly.” No wonder the government and our failing financial institutions are so intent on blaming short sellers.

Let’s get down to basics. Someone who buys long and someone who sells short have the same goal—to make money. And they can only make money if they are correct about the future prospects of the company they are buying or selling.

The idea that a short seller can make money by spreading false information is absurd. If all the readers of this post formed a secret cabal to spread misinformation about Google so that we could make money by selling short Google, good luck to us. We would lose our money as fast as we could invest it.

The reasons for this are clear. Market forces are far more powerful than a few hundred traders spreading misinformation. And why would a short seller try and make money the hard way? Why not do it the far easier way? Why not uncover information about stocks that are truly overvalued because, for example, the true prospects are being overlooked or the company is committing fraud.

Now, here is a key point: In uncovering this information and then selling the stock short, a short seller would be providing a valuable service to the market. First, information is a precious commodity. Those who lack the information that a short seller has may blindly continued to invest in a hazardous way. Secondly, when the inevitable happens and the overvalued stock begins to fall, a short seller actually breaks the fall in price. How? The only way for a short seller to book their gain is to cover their short position by buying the very stock they shorted.

James Chanos writing in The Wall Street Journal explains why short sellers are vilified and the essential role that they play:

In the U.S., we’ve seen how corporate executives have tried to place the blame for their failures on short sellers instead of on themselves. In the end, short sellers—not management—defended honesty in the pricing of shares by demanding accountability. Short sellers openly warned about the problems at Enron, Tyco, Fannie Mae and Freddie Mac before their meltdowns. And when it comes to investigating corporate fraud, it’s the short sellers who are the detectives, while all too often our regulators practice archaeology.

It is not hard to see where this attack on shorts sellers will lead. As the economy worsens, restrictions on the Internet are surely down the road. After all, politicians will tell us about how much bad information is on the Internet. They will say, think how much more confident we would be about the economy, if we were not bombarded everyday by negative analysis on the Internet. Any restrictions, they will tell us, are temporary; any inconvenience, they will assure us, is a small price to pay to get the economy going again.

The mainstream media, having lost market share to the Internet, will surely agree; as will the academics whose livelihood depends upon the largess of government. Government will surely use an economic crisis to strengthen its position by restricting the flow of information.

Of course, it will not end there. Immigrants will be blamed, even more than they are today, for taking away jobs. There will be pressure for at least token deportations.

And then will come the search for foreign enemies.

What the government can count on is this principle of human nature—while we may disagree about who to blame, frightened human beings are all too willing to agree to find an external cause for their misery. The most ruthless members of government will exploit this weakness in human nature.

When we enter this terrible part of the economic cycle that is yet to come, the search for scapegoats will begin in earnest. And in human history, this search for scapegoats has already produced hundreds of millions of victims.

A fixed pie or a shrinking economy is manna from heaven for demagogic politicians. They can offer solutions that blame external enemies, foreign and domestic, for our collective misery. They can tell some groups that they have too little because other groups have too much. Such politicians will feed off the anger, fear, and despair that a shrinking economic pie produces.

We are in the very early innings of this tired human game. Everywhere on Earth that this game has ever been played, it has ended in tragedy and immense human suffering. The outcome won’t be any different here. There is still time to choose a better way.


11 Responses to First They Came For the Short Sellers

  1. James D. says:

    Amen. The root canal analogy is apt, when we blame the pain on the fix rather than the long road of error that lead to it. Short seller are simply today’s scapegoat (though the SEC does need to reinstate the uptick rule). I wish I could accurate predict who would be next, but I can’t even fathom it.
    Sadly, amidst all the pedagoguery being bandied about, they overlook the simple matters that 1. would have prevented this mess, and 2. would fix it. Things like personal responsibility. Accountability. The lack of ethics, responsibility, and accountability in the leadership, both of the institutions that are crashing and the government bailing them out, are the real roots of the problem here. When we need to look for what to fix, the real answer is usually found within ourselves, in acknowledging a mistake we made, taking responsibility for it, looking inward to see why me made it and what to change so we don’t make it again. Until we change the direction we’re looking in for the solution to the problem, we can only look forward to the next crisis.

  2. Jim,

    Indeed! We can be certain that Congress, the Fed, the Treasury Department will ignore the real roots of the problem since they are all among those “roots.”

    A real battle for the future of America is happening. The groundswell of public opinion against this bailout has been surprising in its intensity. We will see how long it lasts. William Greider has sobering words for politicians who think this will blow over:

    If Wall Street gets away with this, it will represent an historic swindle of the American public – all sugar for the villains, lasting pain and damage for the victims. My advice to Washington politicians: Stop, take a deep breath and examine what you are being told to do by so-called “responsible opinion.” If this deal succeeds, I predict it will become a transforming event in American politics – exposing the deep deformities in our democracy and launching a tidal wave of righteous anger and popular rebellion. As I have been saying for several months, this crisis has the potential to bring down one or both political parties, take your choice.

  3. frankvv says:

    Dr. B,

    The President is suppose to sell this to the public tonight. I too am surprised and presently pleased that even some Republicans are pushing back on the blank check approach and I have even heard some utter the words like “we should let the free economy take its course” being uttered. Hopefully the sheep mentality will not take hold here. But I fear we are all going to get swindled and end up drinking the free Kool-aid after “the facts” are presented by our “King”, opps, I mean “President”, tonight.

  4. G says:

    I listened to the Presidential address this evening.

    Let me summarize my simple understanding of the message:

    Companies that are in the business of making money off of the finance charges from extended credit made the fatal error of extending too much credit to consumers. Consumers, drunk off of seemingly limitless credit, forgot that at some point someone is going to have to pay the bill. Uh oh…The bill came due. The money isn’t real! The projected profits to the lending companies disappeared (where they ever really there?).

    Not to worry…we (our fearless leaders) will put a giant ($600 billion dollar) band-aid on the enormous bleeding wound. The “band-aid” will serve to cover up the immediate reality so that lenders can once again feel safe enough to over extend credit and let the consumer make purchases with money that doesn’t exist.

    Prepare to cure your hangover with a little hair-of-the-dog. Never mind the impending fatal Liver failure (that pesky bill will come due again).


    By the way…a big shout-out thank you to the American public from the lenders for paying out the nose for our mistake. By the time you realize that you could have used your $600 billion in tax money to get out from under us, it will be too late.

  5. Steve P says:

    Only those with an appreciation of history and a socionomic perspective could share your sentiments about current events being part of a tired human game. Unfortunarely the majority of our fellow humans remain unwitting players who appear to relish the excitement of participation in the drama of both rising and falling mood trends (or what Thomas Hora might refer to as “existentially invalid” pursuits). I have found Prechter’s insights regarding collective human behavior and Hora’s wisdom and insight into indiviod human spirituality very helpful peronally. Being a spectator of the human drama has psychological benefits, but I share your weariness of the game, because even as spectators, we must remain in the arena, and out of necessity even reluctantly participate from time to time. We can only hope that some good might evolve out of the coming depression.

  6. igli1969 says:

    For years, if not decades, American “culture” has been trying to move people away from the concept of personal responsibility. All sorts of excuses are made: broken home and/or abuse, discrimination, didn’t know that interest rates would go up and home values wouldn’t, and so on. And since the government has a record of bailing out individuals and organizations that have failed, our economy is far from the free market that the media and politicians are blaming for the current mess that they themselves helped to create. A free market is about profit AND loss. Creative destruction insures that ill-used assets will be transferred to those that can make more efficient and effective use of those assets.

    This bailout will help prevent the destruction of organizations that showed remarkably poor judgement. It will NOT teach anyone a good lesson; quite the opposite. And all it will accomplish is to postpone the inevitable reckoning, making it far worse in the process. My analogy is to compare this to a slightly tipsy driver on a slippery road. Each jerk of the steering wheel causes the car to swerve more and more out of the lane, until it runs off the road entirely. Yet just slowing down enough to get traction at the beginning would have ended the problem near the beginning. But the driver wasn’t willing to slow down at all, just as our politicians will do everything to prevent a recession, no matter how much it is needed to correct malinvestment in the early stages.

    I have received a few emails that there will be a “lobbying bomb” Thursday at noon, in which (hopefully) millions of people will send emails or try to call their congresscritters. If it helps to prevent this bailout monstrosity, it will be worth it.

    Chris C.

  7. What a pleasure to read everyone’s astute and heartfelt comments this morning.

    Frank–I don’t think there will be much buy-in to Bush’s remarks but I agree that something will get passed. Nevertheless see Chris’s comments about contacting our reps.

    G–Hair-of-the-dog was a new expression for me. How very appropriate!

    Steve–I’m was really delighted to read your comments that referenced the wisdom of Hora and Prechter. Both have been a major influence on my thinking.

    Chris–The amount of emails and calls have been staggering. I plan on sending a new round today.

  8. James D. says:

    Like G, I listened to the president’s speech last night, too, and I agree. He basically told taxpayers that they were going to ante up (and ante up BIG) to save the institutions causing the problems. And by and large leave the same bunch of criminals in charge of the financial system. What insanity! Section 8 of Paulson’s plan submits that the actions of the Secretary of the Treasury not be reviewable by Congress or the Judiciary. Insane! It would basically give him (or his predecessor) carte blanche in pretty much any scam they wanted to perpetrate against the gov’t and the American people. Its like asking the fox to guard the hen house! Jim Jubak has an interesting take on it (he writes for MSN Money on
    igli1969–What has happened to the American culture my parents brought me up in? When you make a mistake, you fix it. If life dealt you a bad hand (divorce, abuse, whatever), you needed to get yourself together, assess where you were and move on from there, not roll around on the ground in the fetal position sucking your thumb and begging for someone to come bail you out.

  9. alrich says:

    While taking on board the important role short sellers may have in refining price signals in a market, surely there is a contradiction in doing it with non-existent shares, or shares borrowed from people who are happy to hold them — thus distorting those very price signals. I touch on this in the following:

  10. Jim,

    Not only insane but on the face of it unconstitutional. In a America that was sane both would have been fired immediately for even proposing such lawlessness.


    Thank you for your comments.

    You write in your post “There is nothing wrong with making money from other people’s misery — it is and always has been fundamental to the capitalist system.” Actually short sellers prevent misery by exposing rot that would have gone undetected. More importantly one hallmark of capitalism is making profits by serving the consumer. Just think how much misery has been prevented by the increase in wealth that capitalism has produced over the past century. The real exploiters are those who seek bailouts for their failure to produce products that others want to buy.

  11. alrich says:

    Thanks for the reply. However, it doesn’t answer my main query about short selling, that selling non-existent or borrowed shares is distorting the price information in the market, not “discovering” it. It’s rather like printing money – the value of the money falls the more you distribute. A short seller, in effect, increases the share supply so reduces each shares’ value simply by selling into the market. By borrowing shares from someone happy to hold the shares the short seller makes those shares introduce contradictory information into the market — that the shares are wanted as a “hold” and that they are not wanted as a “sell”.

    On the misery thing, I’m all for the market system making good and useful things to maximize our happiness, but doling out misery simply because we hold stocks or are employed by companies doesn’t seem to fit the bill. As it happens, this is what the British Conservative shadow chancellor said a couple of days ago: “Nobody takes pleasure from people making money out of the misery of others but that is the function of capitalist markets.”

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