A Short History of the Bear
by Edward Chancellor
October 29, 2001
The professional life of the bear speculator is normally short and full of misery. Powerful forces are aligned against the bear. They include, the bull speculators, whose capital outnumbers that of the bears by at least one hundred to one; the public, which perceives short-selling as an injurious activity; and politicians, who are always eager to blame the short-sellers for economic woes. In addition, the bear pits himself against the forces of economic progress, which over the past two hundred years have been accompanied by the most tremendous gains in share prices, so that $100 invested in the US market in 1802 would have been worth around $700m by the new millennium.
This essay provides a brief outline of the history of short-selling, the arguments - both reasonable and false - directed against the bears, and the various attempts - invariably futile - to restrain short-selling. Anti-bear sentiment naturally thrives in bear markets. Considering we have entered a protracted market downturn after a great speculative bubble, the experience of history appears particularly relevant today.
The earliest speculative markets witnessed the tussle of bulls and bears. The playwright, Plautus, identified two types in the Roman Forum, in the second century before Christ, engaged in trading shares. The first group, he called, 'mere puffers' (the security analysts of the day), and the second group Plautus described as 'impudent, talkative, malevolent fellows, who boldly, without reason, utter calumnies about one another.' Several decades after the stock market became established in 17th century Amsterdam, a contemporary described a similar conflict between the 'liefhebbers' (literally, the 'lifters-up'), who 'were scared of nothing', and the 'contremines' (the 'underminers'), who were 'completely ruled by fear, trepidation, and nervousness' and who were said to organise themselves into cabala (bear pools) in order to drive prices down. In England, the origin of the term 'bear' to describe speculating for a fall, deriving from a trader who sold the bear's skin before he had caught the bear, first appeared in the early 18th century several years before the appearance of the corresponding 'bull.'
Bears have always been unpopular. In 1609, a Flemish-born merchant, named Isaac Le Maire, organised a bear raid on the stock of the Dutch East India Company. A founding member of the company, Le Maire, had received information from the company's treasurer. Although Le Maire's raid ended in personal failure (we may have some sympathy with his plight as he was driven by the need to feed a family of 23 children), it caused the East India Company to complain to the government, requesting protection from short-sellers, whose attacks, it claimed, were causing harm to 'innocent stockholders, among whom one will find many widows and orphans.' This was the first time, but not the last, that the protection of innocents was evoked in order to turn sentiment against the bears. Although the Amsterdam bourse maintained that the decline in the East India stock was due to poor business conditions - not short-selling, in 1610 the government outlawed all short sales. As with most laws seeking to curtail the activities of bears - the market's natural libertarians - this edict was a dead letter from the start. The Dutch banned short-selling again in 1621 but to no effect.
Towards the end of the century, a Dutch jurist, Muys van Holys, claimed that bears were destroying the credit standing of companies by spreading reports of an unfavourable character. 'They delve into the deepest state and business secrets and do not hesitate to attack even the Government and excite the masses in order to profit more' [he added with a certain inevitability] Widows and orphans are seriously hurt by speculators a la baisse.' Holys suggested a tax on the profits from short sales which was introduced in January 1689. However, there was a rumour put around that Holys confessed to his broker that he had published his plan to tax the bears, 'primarily for the purpose of depressing prices and reaping profits by the recession.' If this were true, it would typify the lack of solidarity that bears have always shown towards their species. Contrary to rumours of concerted 'bear raids' the short-seller has always tended to be a solitary beast, a loner. The bull, by contrast, is a herd animal.
As the stock markets became established in Britain and France in the eighteenth century, further legislative traps were laid to catch the bears. Following the collapse of the Mississippi bubble in 1720, bears, who had profited from the decline in the Mississippi stock, were fined and a law was introduced outlawing short-sales.
At around the same time, the English had witnessed the startling rise and collapse of the South Sea Company, which had risen from around £100 to nearly £1000 in the first six months of 1720, only to fall back to where it started in the autumn of the same year. Some thirteen years later, a Bill was brought before parliament by Sir John Barnard, M.P. Its aim was to 'prevent' the wicked, pernicious, and destructive practice of stock-jobbing [that is speculation] whereby many of his Majesty's good subjects have been directed from pursuing their lawful trades and vocations to the utter ruin of themselves and their families, to the great discouragement of industry and to the manifest detriment of trade and commerce.' Sir John Barnard's Act, as it was called, outlawed the use of futures, options, and short sales of stock (by error of drafting, this was later understood by the courts to relate only to British government stocks). It remained on the statute book until 1860. From its beginning, however, few paid attention to the letter of the law: brokers continued to engage in short sales which were enforced through a gentlemanly code of conduct - 'my word is my bond' - rather than legal sanction.
These two early pieces of legislation against short-selling reveal a common theme in the history of the bears. Bubbles occur when speculators drive asset prices far above their intrinsic value. The collapse of a bubble is frequently accompanied by an economic crisis. Who gets the blame for this crisis? Not the bulls, who were responsible for the bubble and the various frauds and manipulations perpetrated to keep shares high, while they cash in their profits. No, it is invariably the bears who are blamed for the post-bubble crises and are the main objects of anti-speculative legislation. Yet during the bubble periods it is the bears who are generally the lone voice of reason, warning people of the folly of investing in overpriced markets. In the aftermath of a bubble, they continue their forensic work of exposing unsound securities and bringing prices back in line with intrinsic values, a point which must be reached before the recovery can start.
Ever since the trauma induced by the collapse of the Mississippi Bubble, the French have retained a more pronounced aversion to financial speculation than the English. Napoleon disliked bears and believed that shorting was unpatriotic. In 1802, he signed an edict subjecting short-sellers to up to one year in jail. The French prejudice against so-called Anglo-Saxon capitalism continues to the present day: after George Soros and other speculators drove sterling from the Exchange Rate Mechanism in September 1992, the French finance minister, Michel Sapin, commented that 'during the Revolution such people were known as agioteurs, and they were beheaded.' Only the other day, following the fall of the markets after September 11, the Belgian finance minister said he had 'strong suspicions' that the UK markets were used for speculative trading!
Bears have always operated more freely in the United States than in Europe. Despite a ban on short sales by the New York Legislature in 1812, the bear operator was a familiar figure in the nineteenth century. A few gained celebrity. Jacob Little, a saturnine figure, was a leading bear operator in the first half of the century. Known variously as the 'Great Bear,' the 'Old Bear,' and the Napoleon of Wall Street, Little also operated on the long side, and perfected the technique of catching shorts in corners, which became a characteristic feature of the US market. Little was destroyed in the 'Western Blizzard' crash of 1857.
His place was taken by Daniel Drew, also known as the 'Great Bear', Ursa Major, and the 'Sphinx of Wall Street.' Drew was described by a contemporary as 'shrewd unscrupulous, and very illiterate, - a strange combination of superstition and faithlessness, of daring and timidity, - often good-natured and sometimes generous.' He was the great rival of Cornelius Vanderbilt and a sometime partner of Jay Gould. His bears operation sometimes involved the Erie Railroad, of which he was a director. Drew would manipulate Erie's stock upward, sell it short and then 'water' the stock by issuing a vast number of unauthorised shares. Drew is famous for his ditty on the legal obligations of the bear:
'He who sells what isn't his'n,
Must buy it back or go to pris'n.'
Drew claimed that 'anybody who plays the stock market not as an insider is like a man buying cows in the moonlight.' Nevertheless, Daniel Drew was broken in the panic of 1873. Declared bankrupt, he retreated to his bed, where he covered himself with blankets and fought off the demons of half a century's speculation. He died a year later. As I have said the life of the bear speculator rarely ends happily. Even today, there are perhaps only a handful of people who derive a living always on the short side of the market. It comes as no surprise to find after the great bull market that the poorest returns, both risk-adjusted and absolute, belong to the short-only hedge funds.
The roaring twenties, of course, belonged to the bulls. But as the market turned in September 1929, the bears regained control. The celebrated speculator, Jesse Livermore, who as a teenager made his first fortune shorting the stock of the Union Pacific Railroad during the San Francisco earthquake of 1906, made another pile during the October crash. The pool operator, Ben Smith had also turned bearish by this date. When the market broke again, on Thursday 29 November, Smith is reported to have rushed into the brokerage house, where he kept an office, and shouted across the throng: 'Sell'em all! They're not worth anything!' From then on he was known as 'Sell'em' Ben Smith. Both Smith and Livermore became hate figures in the press; both received death threats and Smith's daughters needed the protection of bodyguards.
Smith's call was scarcely an exaggeration. Stocks continued to fall, until by the summer of 1932, the Dow Jones reached a floor of 41.88, nearly 90% off its 1929 peak. By this date, the country's national income had shrunk by 60% and one third of the non-agricultural workforce was unemployed. The president, Herbert Hoover, who came to office in early 1929 with promising that 'the end of poverty was in sight', faced an uphill task in the forthcoming election. America needed a scapegoat.
Wild rumours spread of bear raids, of fabulous profits made by short-sellers, and of political conspiracies hatched by foreigners interested in bringing down the market, the dollar and the US economy. In early 1932, the Philadelphia Public Ledger maintained that 'European capitalists had supplied much of the cash needed to engineer the greatest bear raid in history. These proverbially open-handed and trusting gentleman had accepted the leadership of New York's adroit Democratic financier, Bernard Baruch.' Baruch, the best known short-seller in the country, shrugged off the charge.
Hoover, on the other hand, apparently became convinced that bear raids on the stock market were intended to damage his presidency. In April 1932, a French stock market rag was raided by Paris police, its female editor accused of being in the pay of Russian and German interests who were trying to induce a panic on the New York market. In desperation, Hoover ordered the Senate to open an investigation into the affairs of Wall Street.
In fact, there is remarkably little evidence of organised bear raiding on the US market following the October Crash. In order to dispel the myths, the economist of the New York Stock Exchange, Edward Meeker, published a book, entitled Short-Selling, in 1932. Meeker claimed that bears had not precipitated the crash. In November 1929, the NYSE found that around one hundredth of one percent of outstanding shares had been sold short. A later study in May 1931 found the short interest had risen to 3/5 of one percent of the total market value. More than ten times as many shares were held on margin. Nor could the stock exchange identify any bear raids in the subsequent market decline. A study of large block sales identified the liquidation of long positions as the main cause of weakness. Forced sales by margin-traders also contributed to the decline.
Meeker provided an eloquent defence of short sales. He refuted the conventional charges against short-selling – namely that it is illegitimate to sell what one doesn't own, that short-selling creates a fictitious supply is responsible for declining prices, that it leads to greater price fluctuations, that it is practised only by insiders as a fraud on the general public, that it is simply gambling, that it is a technique to manipulate prices and that it constitutes an attack on the property of shareholders.
Instead, he argued that the bears stabilise prices by providing liquidity and creating demand – by covering their shorts - in a falling market. Shorting was not illegitimate, in his view. 'A short sale,' wrote Meeker, 'represents a debt contracted in goods rather than money'. In this it was similar to many other business contracts. He argued ingenuously that margin trades and shorts were simply the inverse of each other: the margin trader borrowed cash to buy stock, the short seller borrowed stock in order to raise cash. The margin trader closed his position by repaying the cash loan through the sale of the stock; the short seller closed his position with by purchasing the stock and returning it to the lender. It was no less legitimate to borrow a stock in anticipation of decline, than to borrow money and purchase in anticipation of a rise.
Meeker denied that short-selling was damaging to shareholders, since the 'only property which could be diminished by short-selling is an inflated valuation to which the security holder is nowise entitled.' He strongly distinguished between shorting and manipulation, and argued persuasively that a market without short-sellers would be more open to manipulation.
'Short-selling,' wrote Meeker, 'is really an expression of opinion, subject to personal risk, as to the value of securities' Short selling has no effect upon the assets or earning power of operating companies, even in the case of banks. It cannot determine value, but only estimate what prospective values really are and will be.'
It is unlikely that many were swayed by Meeker's argument. The politicians certainly were not. However, the Senate investigation into Wall Street, intended to uncover the nefarious activities of the shorts, found little to go on. A list of 350 leading bear speculators presented to the committee contained only one familiar name, that of 'Sell'em' Ben Smith. Having no luck with the bears, the investigation turned its attention to the bulls of yesteryear. This was much more fertile ground. The Pecora hearings, as they became known after their lead counsel, Ferdinand Pecora, revealed the seamier side of Wall Street during the bull market: the involvement of leading firms and bankers in the manipulation of share prices, the dumping of unseasoned securities on an innocent public, the fleecing of the firms' own clients, the preferential distribution of shares to favoured friends, and so on. In other words, rather similar behaviour to what we have witnessed from the investment banks in recent years. These findings led to the New Deal legislation of 1933 and 1934, which involved among other things, the creation of the Securities and Exchange Commission and the separation of commercial and investment banking.
The bears did not escape wholly unscathed. The Senate hearings discovered that the head of Chase National Bank, Albert Wiggins, had made nearly $4m by shorting the stock of his own bank during the crash of 1929. This was a rather special case. In general, the Senate found no confirmation of bear raids, only innuendo. Nevertheless, bankers before the committee were required to denounce short sellers and some did. For instance, Otto Kahn, the head of Kuhn Loeb, a leading Wall Street firm, declared it 'inherently repellent to the right-thinking man' to profit from the misfortune of others. No specific legislation was introduced against the shorts, although all pool operations, both on the long or short side, were banned. In 1938, the SEC adopted the 'uptick' rule which prevented short sales unless the stock had risen on its last trade. This was intended to prevent bear raids from hammering down a stock and was a continuation of a voluntary rule imposed on NYSE members back in 1931.
The bears of the early 1930s had a mixed fate. Joseph Kennedy, the father of JFK, was appointed the first chairman of the SEC shortly after participating in a bear pool in the stock of Libby Owens Ford. Roosevelt apparently decided he needed a fox to guard the hen coop. Jesse Livermore had a less happy time. He lost an estimated $32 million anticipating a bull market which never arrived. In 1934, Livermore was declared bankrupt. He blew his brains out in the washroom of the Sherry-Netherlands hotel in 1940. The note he left behind, repeated over again: 'My life has been a failure. My life has been a failure...'
The pattern of boom and bust has continued in the post-war years. Inevitably the bears have been blamed during every major downturn. When the investment firm, Investors Overseas Services, which pioneered the fund of funds concept, was collapsing in the spring of 1970, its boss, Bernie Cornfeld, claimed his firm was the victim of the 'biggest concentrated bear raid that Europe has seen in a generation.' This claim was rubbish: IOS had run out of money and ideas. Executives who have reach the end of the road often prefer to finger the bears rather than face up to their own responsibility. During the market downturn of 1990, they were at it again. Asil Nadir at Polly Peck and George Walker at Brent Walker both protested that their companies were subject to bear raids, shortly before the police swooped and their firms went into administration.
At around the same time, the Japanese authorities were complaining that mysterious foreign interests were responsible for the decline in their stock market, following the great boom of the bubble economy. (In 1998, the Japanese imposed restriction on short-selling in an attempt to shore up their market).
Hedge funds, of course, have become synonymous with bear raiding. The first complaint about their shorting activity, to my knowledge, surfaced in May 1970 when a broker petitioned the SEC to ban short-selling and make hedge funds illegal. In the 1990s, there were numerous complaints against hedge funds, relating in particular to the Asia crisis of 1997/98. In 1997, President Mahathir of Malaysia claimed a 'Jewish conspiracy,' led by George Soros, was trying to re-colonise he country. He banned the short-selling of companies in the Kuala Lumpur index. The following year, the Hong Kong authorities started buying large chunks of their own stock market in order to fend of an alleged bear raid by hedge funds. Yet academic research shows that the hedge funds were not responsible for precipitating the Asia crisis. On the contrary, macro hedge funds were one of the few sources of demand for Asian currencies in the autumn of 1997, when the crisis started.
In every instance, when bears are accused of bringing down a market, we find that it was the preceding bull market, with its accompanying misallocation of resources and unsustainable accumulation of debt, which was the root cause of the decline. Today is no different. Earlier this year, as market declined, there were isolated complaints of bear raids. After 11 September these complaints became assumed a more hysterical tone. It was alleged that terrorists had arranged to short airline and insurance stocks prior to the attack on the United States. I do not know whether this is true. However, I am doubtful. As we have seen, in the past foreigners have frequently been identified as leading a conspiracy of bear raiders. And besides, there were good fundamental reasons to short airlines and insurance companies even before their position deteriorated in September.
Nevertheless, last month lawmakers in the US asked the SEC to consider a temporary ban on short trading. According to newspaper reports, UBS Warburg and Bear Stearns tried to limit short sales by their clients. In Britain, the head of the Financial Services Authority, Sir Howard Davies, referred to 'unattractive' cases of 'abusive' short-selling which he suggested might constitute market abuse. He appeared to lend his support to the request by the Association of British Insurers to hinder the stock loan market. Several institutions, including Foreign & Colonial, stopped lending shares. A spokesman for HBOS, the fourth largest bank in the United Kingdom, claimed that the 'profits to be made from stock-lending are dwarfed by the damage that short-selling ' [inflicts] on the life savings of ordinary investors across Britain.' Doesn't this complaint remind you of the East India Company's appeal to protect 'widows and orphans' from the terrors of bears back in the early 17th century?
It has been said that 'progress in finance is cyclical rather than linear.' Certainly attitudes towards short-selling seem to have progressed very little over the centuries. From a theoretical point of view, we know that short-selling exerts downward pressure on prices when they rise too high and vice versa. There is also some evidence that bears are better fundamental analysts than bulls. Without bears, markets would be illiquid and inefficient. Contrary to popular myth, short-selling doesn't affect fundamental values, except during the relatively rare periods when a company is raising money through a secondary or rights issue. We need more, not less, shorting activity if, in future, we are to avoid wasteful bubbles, such as the recent technology, media and telecoms boom.
The most eloquent justification for the bear comes is provided by the American financier Bernard Baruch, who was called to Washington in 1916 after a market panic, to explain his short-sales of the stock of the Brooklyn Rapid Transport Company, a go-go stock of that era. At the time some members of Congress were calling for short-selling to be banned. Baruch stood his ground, politely explaining to the politicians that 'bears can only make money if the bulls push up stocks to where they are overpriced and unsound.' He continued:
'Bulls always have been more popular in this country because optimism is so strong a part of our heritage. Still, over-optimism is capable of doing more damage than pessimism since caution tends to be thrown aside.
To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without a free press. There would be no one to criticize and restrain the false optimism that always leads to disaster.'
Press Room
Press Releases
About DWTA
Bios and Photos
Speaking Engagements
Short Selling
Short Selling Explained
A Short History of the Bear
|
