rruff, Floyd Norris of the NY Times is chiming in right where you and I find agreeement. Transparency and a clear market for stock loans.
select.nytimes.com
By FLOYD NORRIS
Published: September 22, 2006
He who sells what isn’t his’n
Small Business
Go to Special Section »
must buy it back or go to pris’n.
— Attributed to Daniel Drew, 1797-1879
The annals of short selling have no better exemplar than Daniel Drew, whose career demonstrated both the risks and rewards of pursuing such an unpopular strategy. He made, and lost, several fortunes, along the way founding a Methodist seminary that bears his name. He died broke.
In an era when insider selling was not illegal — and, in fact, was deemed a sacred right of insiders — it was Mr. Drew who persuaded members of the New York City Council to first sell short shares of a railroad company controlled by Cornelius Vanderbilt and then to revoke the company’s license to operate a street railway in Manhattan. The idea was that the councilmen, and Mr. Drew, would profit when the share price plunged.
The scheme backfired when Mr. Vanderbilt bought shares, keeping the price from falling. Eventually he owned more shares than existed, leaving those who were short at his mercy. They needed to buy shares to cover their short positions and he was the only possible seller. The city councilmen were allowed to exit with small losses, in return for reinstating the license. It cost Mr. Drew much more to get out.
The market was much wilder in those days, but fights over short selling are still lively. The market’s referee, the Securities and Exchange Commission, finds itself caught between economists, who tend to think that markets are more efficient if everyone can bet on whether a price is too high or too low, and politicians and corporate executives who argue that markets are being manipulated by traders who sell shares without either owning them or borrowing them.
That is called naked shorting, and while it is not the only cause of failures to deliver shares, it is no doubt the major one for heavily shorted stocks. It makes perfect sense: Those who borrow shares must sometimes pay hefty fees if a lot of others want to borrow the same stock. Why pay if you can get the same benefits by shorting without borrowing?
The S.E.C. has a rule that it says has reduced such shorting, but the practice has risen in some stocks and a proposed tightening of the rule may not have much effect.
But a roundtable of economists testifying before the S.E.C. last week produced an interesting idea: Make those who do not borrow pay the same, or more, than they would have had to pay if they did borrow. In other words, use the market to police the market.
That would require shining light on the market for borrowing shares, as was proposed by Owen Lamont, a finance professor at Yale who calls short sellers an “oppressed minority.” The idea was seconded by Charles Jones, an economist at Columbia, who noted that the stock lending market was more transparent back in 1929, before the age of regulation.
If the lending price for any given stock were easily and publicly available, it would make it clear just how overvalued the shorts thought a stock was. Those who failed to deliver shares could be subject to gradually growing fines based on the market price for borrowing.
Making everyone happy is impossible. Some economists, like Lawrence E. Harris, a finance professor at the University of Southern California and a former chief economist for the S.E.C., warn that restrictions on shorting can lead to overvalued shares, damaging the economy by leading to inefficient allocation of capital and depressed future returns for those who buy at the higher prices.
But the companies whose shares are subject to heavy naked shorting say it must be stopped, and they fume at the S.E.C.’s argument that stocks can be manipulated by those trying to force prices up via short squeezes, à la Vanderbilt, as well as by those who dump large volumes of stock in an effort to overwhelm the market.
“Short squeezes have the beneficial effect of creating discipline in the market,” Patrick M. Byrne, the chief executive of Overstock.com, a heavily shorted Internet retailer, wrote in a letter to the S.E.C. Surely, he added, the commission cannot favor “downward price pressure over price increases owing to short squeezes.”
In the long run, prices will adapt to reality. If stocks are unreasonably cheap, because of excessive shorting or any other reason, someone may bid for the entire company, creating a big problem for the shorts. If shares are far too expensive, as Internet stocks were in early 2000, prices will eventually plunge no matter how eager a company’s fans.
Some economists would like to see few restrictions on short sellers because they play a vital role in the price discovery process. But if the S.E.C. wants to continue requiring that shares be borrowed before they can be shorted, then an effort to make the stock loan market more transparent — and force every short to pay the price — makes sense. |
