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Is there social value in shorting?

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Is there social value in shorting?

#1

Post by foomarks »

The value of investing (going long) in a business makes sense to me on a social level: it's people putting faith in other people that they will offer a good business to the market that will help them make a return on their investment. Even more simply put: it's people having faith in other people.

Shorting on the other hand seems to make a mockery of society: it shows the behavior of some people who do not have faith in people.

I think Germany is doing the right thing by banning shorting not only to prevent further liabilities but also to secure faith (even though the press and experts don't seem to think so):

http://www.businessweek.com/news/2010-05-25/german-short-ban-drops-bomb-on-regulators-lawyers-update3-.html

I'd love to know what other people think!

Re: Is there social value in shorting?

#2

Post by hga »

Shorting sends information and that has serious utility.

Having faith in all people, all companies, all industries, all technologies (e.g. buggy whips, punched card ADP) is delusional. If you're basing a ban on short sales on that, you're just sweeping problems under the rug, ones which will get worse and eventually bite back.

Question: are you interested in efficient allocation of capital or something else, and if the later, why is that superior?

However, did Germany ban real short selling or naked short selling? I've read one account that it did just the latter (and I for one don't support naked short selling).

Re: Is there social value in shorting?

#3

Post by foomarks »

hga wrote: post #2

Shorting sends information and that has serious utility. Having faith in all people, all companies, all industries, all technologies (e.g. buggy whips, punched card ADP) is delusional. If you're basing a ban on short sales on that, you're just sweeping problems under the rug, ones which will get worse and eventually bite back. Question: are you interested in efficient allocation of capital or something else, and if t…

Ahh, ok, so blind speculation about even positive outcomes is dangerous (and I can see how this can be just as abused as shorting). So, I can see why paying attention to who is shorting and why they are shorting it is equally important.

Personally: I'm by no means a financial person — just super curious about the usury and trading world and the recent blow up that occurred.

I'm also super curious to see how economics will change from this point forward.

(That article that I posted says that germany wants to ban naked short selling.)

Re: Is there social value in shorting?

#4

Post by Daniel_Newby »

Naked shorts are basically selling counterfeit stock and should be banned. If I saw a naked short seller being burned at the stake, I wouldn't even spit on them.

Covered shorts are a way of renting out a long-term investment that you do not need at the moment. Renting out equity means that the arbitrageurs use it to make the market more efficient. This gives a buyer an improved price today and a seller an improved price tomorrow, with the short seller taking a modest cut for the valuable service they have provided. An analogy is separating land rights (long term investment) from mineral rights (consumption good).

Re: Is there social value in shorting?

#5

Post by joshu »

Does anyone recall the studies about markets or securities where shorts are banned?

I seem to recall that onion commodities cannot be shorted and have a great deal more volatility because of it.

Re: Is there social value in shorting?

#6

Post by hga »

joshu wrote: post #5

Does anyone recall the studies about markets or securities where shorts are banned? I seem to recall that onion commodities cannot be shorted and have a great deal more volatility because of it.

There have of course been some since the 2008 credit crisis and the various bans on short selling and according to The Wall Street Journal the effects weren't good (but take that with a big grain of salt). The example of commodity onion trading is supposed to be the classic one showing it's a bad idea.

Re: Is there social value in shorting?

#7

Post by jayruy »

Seeing shorting as "making a bet against a company" is an accurate, but overly simplistic view of modern financial theory.

Say I want to buy a stock index that includes BP, but don't want to expose myself to their current volatility. I could buy the index and short an equivalent amount of BP to replicate the risk I am looking to take on.

Or maybe I am bullish on BP, but don't feel like I have good knowledge on the Oil&Gas industry. I could buy BP and short a basket of stocks that collectively represented the performance of the industry.

This is what people talk about when they mention "complete markets" - the ability for investors to create any desirable risk profile - insuring themselves against events they deem overly speculative.

When the government bans short selling, it's essentially saying "oops, shit has gotten so bad that everyone insuring themselves would risk the collapse of socially important businesses... we got this one (ie bailouts). don't worry, we'll just take it out of your taxes/currency".

Re: Is there social value in shorting?

#8

Post by hga »

foomarks wrote: post #3
hga wrote: post #2

Shorting sends information and that has serious utility. Having faith in all people, all companies, all industries, all technologies (e.g. buggy whips, punched card ADP) is delusional. If you're basing a ban on short sales on that, you're just sweeping problems under the rug, ones which will get worse and eventually bite back. Question: are you interested in efficient allocation of capital or something else, and if t…

Ahh, ok, so blind speculation about even positive outcomes is dangerous (and I can see how this can be just as abused as shorting). So, I can see why paying attention to who is shorting and why they are shorting it is equally important. Personally: I'm by no means a financial person — just super curious about the usury and trading world and the recent blow up that occurred. I'm also super curious to see how economics…

"Blind speculation" on positive outcomes is I'm pretty sure fantastically worse, that's a cause of the worst sort of bubbles, the ones that destroy money wholesale (deflation), with sobering examples like the Great Depression and Japan's two Lost Decades (and counting ... and only WWII broke us out of the Great Depression).

Whereas covered short selling pretty much by definition has limited effects; for the purposes of the below, A > B > C

It works by someone borrowing (I don't remember the details so I'll accept Daniel_Newby's calling it renting) something and selling it at current price B. The short seller hopes that the price drops, so that he can buy it back at price C and make a profit on B - C - transaction costs etc.

One limiting factor is that unlike normal investing there is no theoretical limit to the short seller's losses. If the price goes up, he has to buy it at A and he loses A - B - etc. So you need to exercise greater care in taking a short position.

Short positions must be reported in the US and that sends information to the rest of the market. As Daniel_Newby points out, covered shorts make markets more "efficient", an important term of art and an important goal.

I've never come across a defense of deliberate naked short selling that made sense to me (it can also happen in "oops" situations, or so people say); as far as I can tell the only legitimate debates WRT it is how extensive the non-accidental type is and how hard should the latter be cracked down on.

Re: Is there social value in shorting?

#9

Post by srgseg »

If I invest my money in a stock, I'd feel safer if other people in the market had had the opportunity to short the stock prior to my investment.

This is because when someone shorts the stock, this results in a sale of the stock, thus pushing the price of that stock down. Thus when they short, their actions help to prevent the price of that stock increase to a level where it is unreasonably highly priced.

So by preventing the stock price from being unreasonably high, this helps prevent me from investing in the stock at an unfairly high price.

People shorting the stock can cause chaos in certain situations where lots of players are highly leveraged and there is significant counterparty risk (in naked short scenarios). However, I fail to have too much sympathy for highly leveraged players because I want them to get burned by the market so they realise it's an unstable and dangerous situation for them to be participating with unreasonably high leverage.

Re: Is there social value in shorting?

#10

Post by elecengin »

hga wrote: post #6
joshu wrote: post #5

Does anyone recall the studies about markets or securities where shorts are banned? I seem to recall that onion commodities cannot be shorted and have a great deal more volatility because of it.

There have of course been some since the 2008 credit crisis and the various bans on short selling and according to The Wall Street Journal the effects weren't good (but take that with a big grain of salt). The example of commodity onion trading is supposed to be the classic one showing it's a bad idea.

There is no ban on "shorting" onions specifically - it is just not traded on the futures market at all. Gerald Ford pushed through legislation on behalf of onion farmers in the late 1950s to disallow it on the futures market. It has been an example of extreme market volatility ever since.
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