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Short sellers defend practice
Question of the Day
They’ve been called the hyenas of high finance, feasting on the misfortunes of others, but the market’s short sellers say they are being used as scapegoats as regulators and politicians around the world struggle to prevent a global economic implosion.
In a central plank in the Bush administration’s response to the market crisis, the Securities and Exchange Commission Friday took yet another step to rein in short selling, the investment strategy by which a trader profits only if the stock price falls.
A day after Republican presidential candidate Sen. John McCain accused short sellers of turning Wall Street into a “casino,” SEC Chairman Christopher Cox imposed a temporary ban on short selling in 799 financial stocks — ranging from battered investment giants Goldman Sachs and Morgan Stanley to local lenders such as Sandy Spring Bancorp.
The ban, which lasts through Oct. 2 but may be extended, was matched by similar anti-short-selling measures imposed by regulators in Britain, France, Ireland, Switzerland and Portugal. In addition, three major U.S. pension funds, including the powerful California Public Employees’ Retirement System, said they were curbing their collaboration with short sellers.
“The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets,” Mr. Cox said.
The temporary ban would “restore equilibrium to markets,” he said.
The move was strongly backed by major financial firms. They contend that targeted attacks by short sellers have driven down their share prices artificially and led to the bankruptcy or forced sale of some of Wall Street’s most storied investment banks.
Short selling essentially is a bet that a company’s stock will go down. In a typical transaction, a short seller will “borrow” a share of stock from its owner — for a fee — and sell the share at the current market price. When it’s time to return the stock to the owner, the short seller buys a share at the new market price; if the share price has gone down in the interim, the short seller makes a profit.
In a riskier variant, called “naked” short selling, traders do not even bother to borrow the stock they are shorting, trusting they can acquire the shares when the time comes.
While short sellers by definition profit from the losses of others, some argue that a ban on their activity will do more harm than good.
Like hyenas, defenders say, short sellers help the market identify the weak and clear out the dead. A strong company can’t be hurt by short sellers; a weak company shouldn’t be protected from them, the argument goes.
Short sellers “were not the cause of the recent financial stock declines,” Jim Chanos, chairman of the major short-selling fund Kynikos Associates, told CNBC Friday.
He said short sellers were merely reflecting the deep emerging doubts about the viability of some of Wall Street’s leading firms as they faced massive problems in the U.S. mortgage market.
“Buying illiquid, risky assets and funding yourself with overnight deposits seems to be a violation of Financing 101,” Mr. Chanos said.
The Wall Street Journal, in an editorial Friday, accused Mr. McCain of using short sellers as a “scapegoat” for larger problems in the financial markets.
“The irony is that his critique puts Mr. McCain in the same camp as some of the Wall Street CEOs who have led their firms so poorly,” the newspaper said. “They also want someone (else) to blame.”
The SEC, itself, appeared to admit that its blanket ban on short selling could damage the market. Many large hedge funds use short selling as a way to protect their holdings from wild market swings.
Wayne Luthringshausen, chairman of the Chicago-based Options Clearing Corp., warned of the “potentially disastrous effects” of the SEC order for such funds trying to minimize risk in their holdings.
Just hours after Mr. Cox announced the short-selling moratorium for financial firms, SEC staff said the agency was seeking a “modification” to the order exempting some hedge funds from the ban.
About the Author
Raised in Northern Virginia, David R. Sands received an undergraduate degree from the University of Virginia and a master’s degree from the Fletcher School of Law and Diplomacy at Tufts University. He worked as a reporter for several Washington-area business publications before joining The Washington Times.
At The Times, Mr. Sands has covered numerous beats, including international trade, banking, politics ...
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