In other words, does the buyer of the phantom shares have no recourse?
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.
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 ...