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THE PROBLEM OF MARKET MANIPULATION Banning Short Selling Is a Bad Idea ... It hasn’t worked in the past — but some seem to think it might just work this time. 
Jamie Dimon, chief executive officer of JPMorgan Chase & Co. Not keen on short-sellers.Photographer: Cyril Marcilhacy/Bloomberg Original article: https://www.bloomberg.com/news/newsletters/2023-05-15/banning-short-selling-is-a-bad-idea Peter Burgess COMMENTARY Peter Burgess | ||
Banning Short Selling Is a Bad Idea
It hasn’t worked in the past — but some seem to think it might just work this time.
Written by John Stepek
May 15, 2023 at 7:27 AM EDT
Welcome to Money Distilled. I’m John Stepek. Every week day I look at the biggest stories in markets and economics, and explain what it all means for your money.
I repeat — banning short-selling is a bad idea
Quick reminder — if you haven’t yet listened to Merryn’s latest podcast with Dario Perkins of TS Lombard, you really should. It’ll give you an excellent framework for understanding what’s going on with markets and inflation at a “big picture” level. Here’s the link.
Perhaps my favourite book on investing is Reminiscences of a Stock Operator (1923) by Edwin Lefevre. It’s the thinly fictionalised biography of Jesse Livermore, one of the best-known traders of the early 1900s.
Livermore made and lost fortunes several times over, with spectacular victories in the panic of 1907 and the great crash of 1929, followed by equally spectacular losses.
I’d highly recommend you read the book, though you should also acquaint yourself with Livermore’s wider life and times lest you be tempted by his rollicking account of life as a speculator — he makes it sound like fun but it certainly didn’t end well.
But today I just wanted to bring it up as I was struck by a historical echo in the news last week from one of Livermore’s anecdotes.
During the panic of 1907, Livermore was heavily shorting the US stock market (in other words, he was betting that prices would go down, not up). He made a fortune. But the scale of the panic became so great that it threatened not just to bring down stocks generally, but the whole financial infrastructure around them.
In those days, JP Morgan (the man) was the closest thing the US had to a central bank. He spent all his time during the panic months corralling the various owners of financial institutions, locking them in rooms to hammer situations out, figuring out whose collateral was still good (so who was still solvent but merely struggling with liquidity, rather than just plan insolvent), propping up those who could be saved, and trying to contain the fallout from those who could not, and generally trying to staunch the flow of fear.
At one point in Reminiscences, Livermore has just made over a million dollars from his shorting of the market (and that’s a million dollars in 1907, which is proper 1%-er stuff, rather than maybe just enough to buy a semi in London’s zone 5). But the havoc and “end-of-days” atmosphere on Wall Street is starting to unnerve even him — though there’s also a hint that he thinks it’s all gone rather too far — and he closes all his shorts.
That very day (I suspect some creative licence here), a broker friend of his delivers a message from an anonymous banker who is heavily implied to be JP Morgan. Here’s the message:
“I want you to go instantly to your friend Livingstone [Livermore’s pseudonym in the book] and say to him that we hope he will not sell any more stocks today. The market can’t stand much more pressure. As it is, it will be an immensely difficult task to avert a devastating panic. Appeal to your friend’s patriotism. This is a case where a man has to work for the benefit of all.”
Why did this spring back to my mind this weekend? Because JP Morgan’s spiritual successor, JPMorgan Chase & Co. chairman and chief executive Jamie Dimon was discussing something similar with my colleague Francine Lacqua last week.
In terms of how to draw a line under the US regional bank crisis, Dimon, it seems, is not keen on short sellers and wants regulators to go after them hard. Not, as he points out himself, that he’s seen any hard evidence for underhand collusion.
Banning Short Sellers Is a Bad Idea
Just as a quick reminder, a short-seller profits from share prices going down. How? They borrow the shares from someone who already owns them. They sell the shares at the prevailing market price — say £10,000 for the lot. They then hope that the price falls. If it does, they buy the shares back — say at £9,000. They return the shares to the person who lent them in the first place, and pocket the difference — in this case, £1,000.
Two key things to remember here: firstly, they can’t keep this deal open for too long — the shares are borrowed and do eventually have to be returned. So unlike “long only” investors, short-sellers have to get their timing right. Secondly, if the share price goes up, they lose money. And because share prices have no theoretical price ceiling (whereas they do have a floor price of 0p) you can lose far more than you originally staked.
So short-selling is a highly risky business, even by the standards of the stock market. That means short-sellers tend to be making high-conviction bets after a good deal of research, as opposed to “buy and hope” investing.
If stock markets are ultimately markets for information — which they are — then the contributions of such a highly-informed and motivated set of contributors to market efficiency should surely be highly valued.
And yet, this idea of banning short-sellers — or at least, scapegoating them — comes up every time there is some sort of panic in the market. It really is a terrible idea that just refuses to die.
The best example here might be 2008. In the run-up, rather a lot of people were pointing out that the banks were in trouble. Contrary to some of what has passed into mythology, it didn’t take a radical contrarian to believe that there were serious problems in the banks, well before Lehman Brothers had gone to the wall.
That whole year was nothing but problems with banks. Regulators across the globe eventually banned short-selling them, bans that lasted for varying levels of time. But it didn’t help. People just wanted out of the banks at any cost, which meant that the selling pressure was being driven purely by “long” investors dumping their shares, not by short-sellers.
The reality is that banning short-selling is a political distraction technique. If the US regional banks have problems, it’s because the ones that have already fallen had overly-concentrated business models, while the ones who are still under suspicion are struggling with the longer-term problem of having to compete for deposits with a “risk-free” asset offering a far higher interest rate than they do. (Merryn has written about a similar, though not as dire, issue facing UK banks here).
Why Short-Sellers Provide a Service
The reality is that short-sellers provide a service. Short-sellers uncovered the Wirecard scandal in Germany, for example (the Netflix documentary on this is very good, by the way, if you’re looking for something to watch).
Keeping an eye on highly-shorted stocks can be a useful thing to do, for two main reasons. (If you have a Bloomberg terminal, typing SPOS |
| The text being discussed is available at | https://www.bloomberg.com/news/newsletters/2023-05-15/banning-short-selling-is-a-bad-idea and |