Thursday, October 02, 2008

Short Sighted Totalitarian Thinking

NOTE, I reworked this post on 10/3, putting the conclusion at the top and my opinion of Beyers' analsys below

Yesterday, I read an article by Tim Beyers titled "First, Lets Kill All the Short Sellers. I was disappointed to find out he was being sarcastic.

The debate around short selling tends to be shrill.

I think that a primary reason for the shrillness of the debate is we've grown accustomed to totalitarian thinking. People want to force their ideas on how the system should work on everybody in the market.

People seem to be driven by some sort of illusion that there can be only one set of rules that control all exchanges. Even worse, people feel that the rules come in the form of absolutes.

People speak as if the options are that shorting should be absolutely prohibited, or that it should be absolutely ubiquitous, and done with no restrictions ... not even the restriction that one most borrow the stock, or the restriction that the total shares short must be less than the number of shares in existence.

I really dislike the affects of shorting. As it is possible for short sellers to massively inflate the float of any stock on the market, I no longer feel comfortable having any money invested in firms trading on the major exchanges. I also no longer feel comfortable having money in mutual funds and find money market accounts suspect.

Now, there are people who are absolutely sold on shorting. I simply do not want to trade any of my labor or effort on an exhange where shorting is allowed.

I suspect that many other people share the same opinion.

Rather than my trying to force my world view on the short sellers of the world. I think the better option would be to have multiple exchanges with different rule sets.

Quite frankly, I think our economy would be stronger if we had multiple exchanges. Perhaps banks trading on an exchange that excluded shorting would be more prone to collapse during a bubble. They would be less prone to collapse during market downturns when shorting becomes rampant. Having a mix of exchanges would mean that only one set of banks collapses during a given market crisis.

A truly free and robust market would have a bunch of different things going on concurrently.

I would really like to push for an open source, real time system that excludes short selling. With a second exchange on the market, people who want to trade equities but don't want the equities devalued by short sellers would have a place to go.

In the Equity Project, I argue that the exchange should preclude shorts. It would do by creating real time stock transfers and by requiring that only the owner of the stock can sell the stock.

I am not arguing the point that my distaste of shorting should be imposed on others. I argue this point from a belief that people who want to share equities in a market where shorting is banned should be allowed to do so.

Having multiple systems with different regulatory regimes is the opposite of short sighted totalitarian thinking that rules the market and discourse about the market these days.

BTW, Tim Beyers article was rather absurd. Mr. Beyers claims that shorting saves us from stock bubbles, and reminds us of all the pain we felt with the burst of the dotcom bubble. I point out that the very fact that the dotcom bubble happened in a regulatory regime that allowed widespread shorting indicates that shorting does not stop bubbles!

My observation was that people who shorted on the upside of the bubble were all squeezed. My one and only attempt at short selling happened on the upside of the dotcom bubble and it was a dreadful fright. The company I shorted at $50 a share jumped to $74 a share! I ended up covering at a loss. Needless to say, my assessment of the company was correct. The stock fell to $3.00 a share within months of my covering the short.

The claims of the short sellers works only if the short seller is altruistic and has perfect knowledge.

People shorting on the upside of the bubble were squeezed. The squeeze added artificial pressure to the absurdly high prices.

The major shorting that happened during the dotcom bubble happened on the downside of the bubble. This leads to the argument that short selling simply magnified the hurt of dotbust. If my observation is true (people shorting on the upside got squeezed, while short positions increae on the downside), then shorting simply adds to market instability.

In the 2008 crisis, shorters added to their position with each down tick in the market. If the short sellers had started buying back big time a month ago and saved us from the bank failures and government bailout, then I would be standing on the highest tower exalting the benevolence of the short seller.

It appears that shorts are not altruistic and have the same irrationally exhuberant mantality as the herd of longs. They keep increasing their position until crisis occurs.

Now, when a long bubble pops, the long investors are the hardest hit. When a short bubble pops, the economy at large suffers.


Scott Hinrichs said...

"I think the better option would be to have multiple exchanges with different rule sets."

I like this idea. Competition between exchange systems would be very healthy. We've got the NYSE and the NASDAQ. It's better than, say, having a single Fed for the currency market, but it's not enough.

y-intercept said...

That sentence was what I wanted to say when I started writing the post. The point that shorting would be good if it happened on the upside of a spike was a flow of concious refutation of Beyers' view.