Anybody who knows about clearing firms I would like to know when naked share positions are closed where does the money come from to fund the account that was naked?
Fund? Good question... We should expect in a normal buy/sell transaction that money is exchanged between the accounts of the buyer of the stock that was sold by the seller. But when a naked short is initiated, what's really being borrowed is cash (because no stock was actually located to be lent). Which means the brokerage is actually collecting interest on a cash loan that requires the borrower to return a share of stock at some point in the future via a market transaction.
Now.. this is pretty much the same transaction that is initiated when someone actually borrows cash against the equity of of the stock they hold in a margin account. Where does the cash come from to fund that? It comes from the brokerage, right?
But they aren't really the same transaction.. If someone loans me money to buy stock that's a cash loan and has no effect on the actual number of shares outstanding. My purchase of a stock with that borrowed cash is a separate transaction that independently affects "price discovery" via supply/demand.
However, if I take that cash loan with my stock equity pledged as collateral, and use it to buy more shares of the stock, am I actually increasing the number of shares outstanding? No. Presumably some current owner will sell it to me at a market price. What that cash loan against my stock does is increase demand, which should increase the price of the stock. But since my broker has a lien on that collateral stock, he can loan it out for a LEGITMATE short sale which would, in return, offset that increased demand by providing increased supply in the form of the loaned out stock.
But when someone is NS, it is, in essence a cash loan because no stock was actually loaned to be sold. They sold stock that didn't exist, but money was shifted from the account of the person who bought that non-existent share who has suddenly been defrauded because he can never receive the property he just purchased, those shares of stock. All he gets is an IOU from the broker, a pledge that the broker will have stock on hand when that owner decides to sell his shares.
And what results?.. "Price Discovery" is circumvented as a flood of non-existent shares are sold into the market. And if you're long and on margin, you get margin called and your shares sold. The NSS's?? They go in and buy your shares during your panic, and then return them to the broker.. transaction completed.. share inventory restored..
In essence, brokerages are becoming "fractional" banking systems, thinking they can extend cash loans based upon a percentage of depositor assets, in this case shares of stock they hold in street name on behalf of shareholders. And from the brokers perspective, they really want (and need) that additional source of revenue from margin interest. And since all short sales equate to a margin transaction, it's in their interest to perpetuate this.
Sorry for the long response.. but I just want to use the response as a way of making sure I was understanding it all properly. Sometimes all this NSS stuff just makes my head spin.. ;0)
Hawk |
