Short Selling

On March 16th, The Daily Show with John Stewart aired a piece on short selling. Now up until this point I thought "Short Selling" was the practice of intentionally lowering the price of a stock through what I consider to be the "stampede effect." By creating movement in the price of a stock, casual traders see that downward movement get scared, stampede like cattle, sell off everything driving the price down to an undervalued low. The "Short Seller" would then snap up these stock that were undervalued, using the liquidity that was gained through created the stampede, essentially multiplying the number of stocks they hold. As normalcy returns, they now have stocks that are worth the same as they were last week, but they have more of them by capitalizing on the stampede. I did not have any particular opinion on this matter as in order to succeed, the stock ultimately had to recover from it's demise. However this piece showed me that either my knowledge was wrong, or was simply talking about another practice, so I decided to get some education on what 'Short Selling' was.

So thanks to the all knowing and powerful entity only referred to as "Wiki," I now have some of the basics about short selling within my understanding. Basically, "Short Sellers" are borrowing a stock, selling that stock (which they do not own) then when the stock goes down, they buy the stock back to return to the original holder of the stock. I'm no financial genius, I certainly have never even taken a business course, in fact spending 30 minutes reading the Wiki on Short Selling, has expanded my knowledge of financial markets by an order of magnitude. But this seems fundamentally flawed.

People knowledgeable about the markets claim that short selling is a vital part of the process. When the downward march began in September 2008, bans on short selling were enacted by many of the G20 countries. Those bans have been lifted in many cases with the financial gurus claiming the ban was a mistake. I fail to see how it could possibly be a mistake. Right now there are some very scared, very stupid, people out there increasing the downward trend that current conditions have created. Every day that passes without a end in sight, that stampede only attracts more investors. Seemingly this would create an environment where short sellers are then gods capitalizing on every scared citizen out there who just wants to be able to retire. Now add to that the fact that the Daily Show has also pointed out the major financial news network, CNBC, has in many ways been completely and total abdicated their responsibility to confirm facts, independent of the lies being told to them by CEO's. What moron would assume that a CEO, whose primary responsibility is to protect the shareholder's value, would go on CNBC and say "Well we are in bad shape, I honestly don't know if we will be bankrupt in one month or two." It is their JOB their entire meaning of existence to create positive expectation for their company. CNBC did nothing. In fact their failure to report the truth, could easily be taken as hiding the truth from the average person and thus allowing them personally to make their moves to capitalize on the inevitable downswing.

These financial reporters and investigators are not idiots, they are aware of how short selling works. They find out that a company is going to tank, like Bear Sterns, they fail to report that while they set up their short sell, the higher the price of the stock when they begin the short sell transaction, the more they profit. So they go on TV and report only what they have been explicitly told by the CEO's and fail to mention the dirty little "unconfirmed" secret they uncovered. This generates false promise in the stock, they then just sit back and wait for the inevitable and cackle gleefully all the way to the bank when Bear Sterns drops from $65ish to $2 in 5 days. Every $1000 worth of "borrowed stock" would result in a profit of $970 minus the cost of borrow the stock, which even if I used an extremely high number of 7%, still results in $900 profit for every $1000 borrowed. For someone to be able to profit like that from simply not going live with information that would devalue the company, is wrong in every sense of the worse. Warren Buffet, you may be a financial god, but I must believe your insistence on the "good" of short selling, is backed more by your desire to profit from this bear market, then your desire to protect the average person approaching retirement.

The fact that someone can make insane profit from the absolute destruction of a stocks value, is a very troubling notion that should raise the ire of anyone who has any common sense. It is well known that it is easier to drag someone down, then to lift yourself up. By allowing a system where savagely destroying a stocks value can result in massive profits, you are rewarding people for creating fear and giving them incentive to destroy the lives of people holding that stock, and the employees of that company. While I know any money earned is ultimately taken from other people, this seems like a malicious perversion of that theory. This financial crisis speaks to the extreme weakness of the free market economy and ultimately the solution likely requires a diversion from the debt based economy we now have.