Wall Street's Naked Swindle
rollingstone.com
rollingstone.com
I can't take this sort of writing seriously in an article like this. It's fine for an internet rant that is supposed to make me laugh. In an article that is pretending to be an economic analysis, well, I quit reading.
I did see something about naked short selling. Naked short selling sounds fraudulent to me, but I'd like to read a intelligent defense of it from supporters of the practice. Anyone know of one?
In general it's disallowed because people just betting on the price of stocks instead of owning them (at least in some derivative way) is considered a bad idea.
For example, Google is allowed to trade on the fact that it's doing biz with Intel. Google's employees are not.
Google shorts Intel stock just before announcing to the public that the deal is off and it's Intel's fault? I don't think that's exactly allowed.
http://www.businessinsider.com/john-carney-why-matt-taibbi-i...
One expects "no" will be followed by supporting argument. Instead, we see more argument for same. After all, the "other party ... vigorously" is just as true of stocks as everything else.
Note that the argument against short selling is actually driven by folks who argue against it because they think that it "unfairly" drives prices down and lets people profit from that. They bring up non-delivery because that's an appealing argument, but it's not a huge problem and it's not what they're trying to stop.
Yes, I know about the VW short-squeeze a year or so ago. What of it? (Before you get too excited about the fact that some folks lost a lot of money, make sure that you understand WHO lost a lot of money.)
It's only illegal when you do it to manipulate a market or if you intend not to deliver the shares.
In naked shorting when someone buys a share from a naked shorter in a stock exchange, they do not agree to buy a fake share or a share that will not be delivered. Instead they expect to get a real share. So if the naked shorter does not deliver the share by the end of the three day period it is violation of contract.
The difference is that Nintendo can complete your order - if it were a naked short sell then the seller knows they probably can not genuinely get hold of the shares that they sold you, it may be impossible, Some other trade may have had a promise to borrow those shares and may have sold them to some other buyer.
Nintendo may well actually have stockpiled your Wii already awaiting delivery (I think this is the most likely position).
In the event Nintendo doesn't build the wii, they refund your money. The naked short seller also needs to pay a large penalty.
Naked short selling is more or less the same as "naked wii selling". That's why it's only illegal when you are attempting to manipulate the market.
Theoretically Nintendo could sell more than they can ever manufacture, but they at least are able to manufacture the product at the point at which they pre-sell it.
The NSS is more like Nintendo now pre-selling a Star Trek holo-deck - they'd know it's almost certainly not achievable.
I flagged it - it doesn't seem very germane to hacker news, and comments like the one you cite seem to set people off in directions that meander ever further away from the topic. And that includes 'intellectual curiosity' as part of the topic; mine certainly isn't satisfied by politicized ranting.
It's also amazing that we have to turn to Rolling Stone for this kind of investigative reporting. Where is the rest of the Fourth Estate?
For a market to work well you want liquidity, in order for the traded prices to reflect all the information known to market participants. One of the problems in the UK electricity market (which happens to be my day job) is that relatively few companies trade other than those who physically produce or use electricity, which hampers the effectiveness of the markets and (probably) increases the prices customers end up paying for their electricity.
So why are shares so different to any other market? Why should only people who physically own them be able to trade them?
Presumably the attraction of such a policy is that it allows share prices to remain artificially high. Even if many market participants believe that a price is too high, they won't necessarily be able to act on that belief, and the bubble will remain inflated. But is that such a good thing in the long run?
Naked short selling sounds fraudulent to me, but I'd like to read a intelligent defense of it from supporters of the practice.
So you think it is illegal, but would like to know how would practitioners justify it? Kinda perverse, like asking rapist how would (s)he defend rape.
Here's standard Naked Shorts' defense: it provides liquidity and makes markets more efficient.
Seriously, Overstock.Com? They're still losing money. The shorts were right.
For the other side of the shorting story, look at what happened everyone shorting VW in 2008 when Porsche upped their stake to 75%. It briefly became the highest value company in the world, as every short seller had their lunch eaten trying to find the few remaining shares to deliver.
Also naked shorts allowed many people to profit unfairly, by doing something that is illegal but it is not properly enforced.
Regarding the VW story, were naked shorts even involved in that? I don't think VW trades in US exchanges and I am not sure whether naked shorts are a factor in Germany. NAked shorting should be differentiated from ordinary legal shorting. Legal shorting is not that problematic because there is a natural limit to it. Theoretically naked shorts can crash any company because they can flood the market with an enormous amount of shares.
Edit: That, alone, is a tad too much snark with a tad too little data for me to leave it unadorned in good conscience. Here's a couple points of interest:
1. In 2003, the Zimbabwean economy shrunk by 18 percent.
2. In 2008, the estimated inflation rate in Zimbabwe was 231 000 000 percent.
3. By late 2008, official statistics put that at 516 quintillion percent
4. The Zimbabwean Dollar officially ceased to exist on 1 July, 2009
(quoth Wikipedia; I'm not making this up).
Edit again: On a non-economic front, it might be interesting to note that Zimbabwe's life expectancy is in the mid-30s for both sexes.
https://www.cia.gov/library/publications/the-world-factbook/...
Seriously. There are still people alive who remember the Great Depression. Go find one and ask what it was like. We're not even close to that.
The problem is that we have traded debt (future labor and products) for currently assets as if it where a current asset (and we convinced the rest of the world to do so too). The problem is that you can continue to sell the future (debt) until someone looses faith in that return then the whole thing comes crashing down.
I really think we should go back to a hard asset economy as it is less susceptible to crashes in valuation and is far harder to manipulate. The problem is when only current assets are valued. Prosperity tends to shrink and amass in the hands of a few. It really is a catch 22.
I don't think a nation's economy, resilient of not, gets to print two trillion twice, and since we haven't yet fixed the fundamental issues that got us here: trade deficit and federal deficit, we'll need another bailout soon, but it will cost more, something like four trillion. The world knows it, and that's whey they're moving away from the dollar as fast as they can. There is not much in the US economy for the rest of the world any more. If we do the right thing and pay our debts off, that means drastic consumption cuts, and if we don't then we just continue to consume with credit. So you see, it's a lose-lose for the rest of the world.
In other words, does the buyer of the phantom shares have no recourse?
I would love to hear if anyone knows how this works.
Think of it like a bet. If next Friday the share price is over a $100, I'll pay you the difference between whatever the price on the open market is and if it's less than $100 you pay me the difference.
http://www.thisismoney.co.uk/markets/article.html?in_article...
If the short seller is blown up or cornered, in other words if the price of the shares has climbed so much that the short seller will lose money, then you might be trying to sue somebody who is already in bankruptcy.
So that is another problem of shortselling: it affects not only the companies but buyers as well, because buyers may end up holding stock that does not actually exist.
An extremely contrived example:
Say a company has a 1000 shares of stock out in the market.
The broker buys 250 of the shares to sell to the person who wants to short the stock.
So if you were looking at this stock from the outside you'd think: "There are 750 shares where people think the price of the stock is going to go up (or why else would they have bought it) and there are 250 shares where people are betting that the price is going to go down (which is how you make money by going short)".
Note the 750 shares + 250 shorts = 1000 shares
So if someone wanted to short this company on 500 shares, the broker can't find the extra 250 on the open market so they sell the short positions even though they don't have a stock to associate against the last 250 (hence they are "naked").
So you have: 750 shares + 250 actual shorts + 250 naked shorts = 1250 positions in the market on a company that only has issued a 1000 shares.
So now you're an investor and you're trying to guess what the future share price of a company will be and you have:
Company A with legit shots which you can think of as 750 bets the stock will go up vs 250 bets the stock will go down.
and
Company B with naked shorts which you can think of as 750 bets the stock will go up vs 500 bets the stock will go down.
You'd look at the two of these and go: "Gee, there sure are more people in the world that think Company B's price is going to go down. I'm going to sell my Company B shares before they really tumble and buy up some of that good Company A."
So the naked shorts make Company B look less attractive which drives the price down further (making more money for the short positions).
Yet Company B does not necessarily look less attractive - a high amount of short sales might mean a rise in the price when people cover (buy back) their shorts.
The core issue is that there are two different sets of rules applying to Company A (no naked short selling) and Company B (naked short selling), but to an outside observer it would appear that there is only one set (no naked short selling as per regulations).
This messes up even things like what you are describing: as half the shorts on Company B are naked, there aren't any shares to be bought back, so there would likely be less of a rise than what you would expect.
No. The entity that wants to short will locate (or get their PB to locate) shares to borrow that they will then sell, in order to short. They will pay interest on that borrow, and it can get quite expensive if that stock hard to borrow. They have to return the shares at some point - either when they decide to cover their short, or the lender recalls them.
Either way, the lender is still "betting" on the price going up, as they will get the shares back at some point in the future.
The problem is with naked shorts where you sell without even locating. Or when you put 'three dots' (as the Goldman Sachs compliance officer remarked in a conference) in the text field to report where you have located or borrowed the shares.
In short (pun intended) selling without borrowing proves destructive for the price of shorted shares.
Anyone want to buy Manhattan, ... the title deeds, oh I'll show you them next week.
It's not even a matter of attractiveness (although false rumors would definitely fall in that category).
If you have more people trying to buy a stock than those willing to sell (at the current price), the price will rise until more people are willing to sell or fewer people are willing to buy.
Likewise, if more people are looking to sell (at the current price) than to buy, the price will go down until people are either no longer willing to sell, or more people want to buy.
Naked shorting creates excess supply. You suddenly have A LOT more 'shares' being sold, without a corresponding increase in buyers.
As such, the share price declines. Couple this with nasty rumors, and the declining share price doesn't entice any new buyers (which is normally the case when something gets cheap). As the price caves further, and the rumors persist, existing owners start to worry, and decide to get out before it gets worse. Now the downward spiral is in full force. Everyone wants off the sinking ship.
Can you explain how the company goes out of business as a result of this? Suppose the company is basically sound. Through stock manipulation its share price goes down to 1 cent. But the company continues doing whatever it does (and can purchase its own shares back at a bargain price to boot).
But Bear, Lehman, and numerous small companies that are usually the victim of this tactic, were leveraged to the gills, and were full of nasty liabilities. The temporary crisis of confidence caused by a falling stock price led creditors to start fleeing as well, preventing Bear from rolling over it's daily debt. As they point out in the article, Bear was highly dependent on overnight lending at that point.
Also, making money via naked shorting doesn't require the company to die. It merely requires the share price to fall.
Someone owns the company for a few hundred dollars which was yesterday valued at tens of millions. The company has assets worth millions [of currency], they can wait for next years dividends or liquidate ... what to do ...
It's sort of like calling a revolving credit line; if the lender really needs the cash back, they can do it, but most of the time, they don't, and meanwhile, everything you've bought with it is real money for all practical purposes for anyone receiving it.
That's just a guess, but logic would suggest I am right. Who in their right mind would buy shares they know are phantom? I think the whole point is that the status of the shares is opaque to the buyer.
There are lots of these kinds of transactions in markets; there is some sort of virtual "advance" followed by some sort of belated follow-up/collection effort/call to actually settle the gap. The receiver doesn't know the difference. To some extent, these transactions support efficiency; it's just like if I borrow $1500 from my friend for 3 days to pay the mortgage due today while waiting for money to come in a few days later (an actual situation resembling what I face as a bootstrapped small business owner every month, minus the friend to borrow from!). But when it gets out of hand on this scale, it gets out of hand.
Like most financial systems there's how people think it works and then you look at the actual mechanics and it's quite different; this often leads to semi-informed people thinking they know more than they do.
Read here:
http://www.law.cornell.edu/ucc/8/
...section 5 (pretty accessible as legal codes go) for the basics.
Essentially the laws are structured so that when you buy securities through an intermediary:
- "purchasing" shares through an intermediary doesn't instantly give you the shares; it immediately gives you a legal claim against the intermediary to produce those shares
- the type of claim you get is very standardized (in terms of delivery times and rules around it, etc.)
This makes complete sense if you think about the early years of the stock market. If you went into a brokerage in Chicago in 1940 and bought shares in General Motors, would it really be reasonable to get an actual share certificate instantly? Within an hour? What if it's not Chicago but Poughkeepsie?
So the fraud-minimizing solution is that: "purchasing shares" from an intermediary grants you an enforceable claim for those shares that you purchased, but doesn't instantly give you actual shares (it couldn't then, economically).
(Needless to say this pushes some of the risk onto intermediaries: since you are buying at whatever price the agent quotes if the stock price were to change then the agent can't ransom "your" shares to you for the post-agreement price change.)
A consequence of combining this general setup with the modern electronic infrastructure is that what is essentially fractional-reserve stockbroking becomes possible (if enough brokerages are in on it and if the regulators aren't vigilant enough).
The current claims about naked short selling basically reduce to a claim that certain aspects of the order-clearing system are being exploited for fraudulent profit (essentially unregulated fractional-reserve lending, but the specific dynamics are a little different due to the nature of the assets involved).
Part of the issue is that if the scam works as the naked-short-selling people think it does then it works best when the naked-shorted company goes out of business within a reasonable time period from when the scam commenced (due to the specific mechanics of how the claimed scam is supposed to work); this makes it hard to accurately assess the merits of many of the claims, since the companies supposedly targeted are usually long-since gone and whenever a company goes out of business there's usually plenty of reasons why it failed that don't involve stock market shenanigans.
1) Hedge fund wants to short Bears Stearns
2) Hedge fund borrows 1M shares and sells them. Deposits its money with a Prime Broker.
3) Stock in Bears Stearns falls in price and hedge fund buys back the 1M shares it shorted (making a profit)
Now, where this gets insane is the shares the hedge fund borrows don't actually exist (it sells stock it does not have, delivering IOUs to the stock buyers and by dumping those non-existent shares it depresses the stock price)
> Instead, Wall Street now serves, in the words of one former investment executive, as "Lucy to America's Charlie Brown," endlessly creating new products to lure the great herd of unwitting investors into whatever tawdry greed-bubble is being spun at the moment
The salient point of the article is calling out the obvious and rampant corruption that is strangling our economy; naked short-selling is an example to explain it.
Speaking of economists, reading The Economist is a pretty good way to get your feet wet initially. It's a magazine, but its pretty in depth, but at the same time doesn't assume you're an expert on all parts of the system.
I read this entire article to her out loud and she was actually impressed with the accuracy of what is usually sensationalist writing from the Rolling Stone.
As programmers who like to make black and white or otherwise binary decisions about things, I'd say we'd be the least qualified to make bogus or unfounded statements.
I'd avoid relying upon articles like this one though, from my experience they're frequently wrong.
I've been a developer on the leading equities analytics software, was lead developer on the worlds largest credit derivative trade settlement platform, and now work in currency trading. I don't have a huge in-depth knowledge in these areas, but I know enough that I can tell most of these articles are written by people who are completely clueless.
I'm not aware of any book that describes all the major parts of finance in one go, but Warren Buffet's shareholder letters (which have been collected in book form) are a good place to start. He explains so clearly what business is and is not that I think it will arm one with a good signal-to-noise filter. I think the hacker feels that highs, lows, Jim Cramer's screaming, stock charts, naked shorts, uptrends/downtrends, and all that other stuff is a basket of canards, but is unable to articulate this; armed with the knowledge of how and why exactly public corporations work and what their stock is for, he should be ready to use the same patterns of knowledge to tackle the rest of finance.
..the hyperinflation fearmongers, the deflation fearmongers, Austrian economics true believers, Randists, socialists, And most of them are wrong.
And in case you haven't noticed from the recent bank and financial mess, economics and finance are related.
We only have vague understandings of the macroeconomics of finance, so that stuff isn't really worthwhile to people not interested in economics.
Maybe that is precisely why the Great Depression, this current mild depression/steep recession, and other financial messes throughout history catch people who "only have vague understandings of the macroeconomics of finance" by surprise.
"This really isn't about my company," Byrne says. "I mean, I've made my money. My initial concern, of course, was with Overstock. But the more I learned about this, the more my real worry became 'Jesus, what are the implications for the system?' And given what happened to Bear and Lehman last year, I think we ended up seeing what some of those implications are."
Banks weren't out to swindle people with all those 'new' investment funds, they were reacting to overwhelming demand from the managers of 80-something trillion dollars. That overwhelming demand was driven, in part, by the fed holding the discount window open for so long.
If we remove the author's notion of 'evil' intent on the banks part, for which there is little to no evidence, and chalk it back to 'incompetence' instead, the author's article becomes a rehash basic economics and a lot of empty hyperbole.
For a more dispassionate recap of the debacle, I'd recommend This American Life's article, the Global Pool of Money.
http://www.npr.org/templates/story/story.php?storyId=9032768...
We'll be forever wondering what the landscape would have looked like if those banks had been allowed to collapse.
I personally think that short term we'd have been much worse off, but longer term quite possibly much better.
That passage is a little alarming. A run on US government debt could be triggered by American financial firms themselves.