Get Shorty

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The fallout from the financial crisis has not been all bad. In fact, for a few, it's been quite beneficial. Lobbyists, arms manufacturers, big tobacco and dictators, for example, can now feel comfortable introducing themselves at cocktail parties with no embarrassment for their professions. That is, as long as an investment banker is also present. Better still if someone is there who confesses to shamelessly short selling the market.
 
Short sellers are the new bogeymen of the 21st century. They are constantly lambasted by the media and politicians for allegedly dragging down the market and destroying sound businesses to make a quick buck. Just last year the U.S. Securities and Exchange Commission (SEC) and the U.K. Financial Services Authority (FSA) banned short selling to prevent the collapse of more venerable banking institutions. This sparked a wave of similar actions by other regulators across the globe.
 
Prime Minister Gordon Brown defended the ban, claiming that "when a group of people are exploiting a difficult economic situation, it is right to stop it," and then added that it "would be wrong for good companies to be brought down by speculators."
 
Restrictions on short selling have since been lifted in the United States, the United Kingdom, Australia and Canada. But bans are still in place in Belgium, Austria, France and Germany, and they are unlikely to be overturned any time soon.
 
Why? Because it's politically expedient to blame the financial collapse solely on the pariahs of Wall Street and Canary Wharf. I shall explain.
 
Let's start with the act of short selling. It is not a zero sum game, and like any other type of trade, you can get burned. The difference is that a short seller loses if the stock increases in value. Just look at what happened with Volkswagen last year when hedge funds lost around €30 billion on the presumption that the company's stock--already soaring--would fall. The news that Porsche planned to increase their holding in the company led to another surge in price. For a brief moment, Volkswagen was valued as the biggest company in the world. And short sellers lost billions.
 
In more general terms, even if Hedge Fund A decided to short sell stock for Business X and successfully drove down the price, Hedge Fund B may take a chance and buy said shares at a lower price. If Business X is actually in good shape, Hedge Fund B just invested in a bargain and Hedge Fund A handed it to them on a silver platter. But any sane hedge fund manager knows that if a business is in good shape there is much more money to make from going long.
 
And short selling stock in a healthy company doesn't quite fit the stereotype of the investment banker. Since when did these guys in silk top hats, fat cigars and the global proletariat at their feet have an aversion to making money? Are short sellers secretly students of Marx toiling to bring about the collapse of global capitalism?
 
Short selling is only used by investors to make a return on a business that is in trouble. Therefore, we should welcome--not ban--short selling because it acts as an early warning sign. We would be shooting the messenger otherwise.
 
Of course, the SEC has done just that. Just before the collapse of Lehman Brothers, David Einhorn, of Greenlight Capital, stood before several audiences and announced he was shorting Lehman Brothers stock because of its suspect accounting, which he recounted in detail. "The SEC responded by demanding to see his firm's e-mail, hinting darkly that he was part of some conspiracy to drive Lehman Brothers out of business, and generally making him feel that he'd pay a price for telling the truth," reported Bloomberg.
 
And they complain that short selling isn't transparent enough.
 
Short sellers were not to blame for the collapse of Lehman, Bear Stearns or AIG. A broken business model was the real culprit. The same can be said of Northern Rock, Halifax Bank of Scotland and Royal Bank of Scotland in the United Kingdom.
 
Still, they were chastised after Northern Rock, HBOS and RBS stock plummeted. And politicians such as Vince Cable were quick to oppose lifting the short-selling ban, and to point their fingers at the City Boys who seemed hell bent on destroying three of the great institutions of British banking.
 
Note: These same politicians have been unable to name, amidst their scathing remarks, a robust entity that collapsed because of short selling. That's because one doesn't exist.
 
Now we know all too well that these banks were over-leveraged and awash with toxic 'assets'. In the instances of Northern Rock, HBOS, RBS, AIG, Lehman and Bear Stearns, investors shorted the stock because they wanted to make money out of moribund financial institutions built on shaky foundations. These trades merely hastened their inevitable demise and provided a sort of warning system for a wave of collapses that no regulator could have foreseen.
 
Nevertheless, the SEC and the FSA have hinted at tougher restrictions on short selling in the future. Such a move would be lunacy. Through banning or restricting short selling, the regulators actually boost stocks that would not otherwise appeal to investors. One might ask why the government wants to push the public towards investing in bad stocks, which would jeopardize not only the health of the market, but their own pension funds.
 
Short selling has never been, and never will be a problem. The only people making it a problem are politicians, and those heading up broken financial institutions who very likely practiced the trade in their lifetime.
 
And while our representatives have an obligation to prevent such an economic catastrophe from happening again, they seem far more focused on sloganeering and creating bogeymen to distract the public from their own shortcomings. Therein lies the problem.
 
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