Friday, March 06, 2009
Jim Cramer on short-selling
I rarely watch Jim Cramer's "Mad Money" because I am not usually home in time and in any case his shoutinig gets on Mrs. TH's nerves, but the stars aligned this evening and I caught his rant about short selling and the regulation thereof. I thought it was both intersting and entertaining, and until one of my smarter commenters talks me out of it I am going to say that I agree with him.
MORE: Contrary opinion is piling up in the comments.
9 Comments:
By 
, at
Sat Mar 07, 02:34:00 AM:
Let me see if I have this correct. I destroyed the world economy because I bought short ETFs. Wow, and I thought I was just protecting my family from financial ruin, how uncollective of me. I should have stayed in my mutual funds and lost 70% of my nest egg.
By , at
Sat Mar 07, 05:11:00 AM:
Tigerhawk, I thought you were pro- freedom. Short sellers engage in voluntary transactions with willing buyers and lenders.
If and when they make huge profits, it is because they take on huge risks. When you short a stock, generally everyone in that company is directing their energy against you, since they want it to succeed rather than fail.
Our economy arguably suffers from a lack of short sellers. Short sellers have enormous incentives to expose fraud and mismanagement at target companies.
Right now, I'm structuring my finances and life to short the Obama administration, an enterprise that is guaranteed to fail.
By , at
Sat Mar 07, 07:31:00 AM:
Tigerhawk:
Capital markets are the best allocators of resources, but only if the premises hold: many small independent agents, free to act, no monopolies, no subsidies, and no "too big to fail."
The problem today is not short-welling, but that there are too many "TBTF" institutions. If they were smaller and more numerous, Darwin would make short work of the cleansing.
We now use metrics (the Herfindahl index) to check monopolies. There must be an equivalent, based on market impact of failure.
When a bank especially gets too big, it gets a choice -- break up or closer regulation, to recompense us for the implied cost of safety nets.
Regulation is now a sad Rube Goldberg device (paper on request), so no one told that truth to Sandy Weill. Hence the Citi debacle.
AIG is a little different. It ought to have failed, and sticuk those who piled on to its underpriced credit bets. The real policyholders are well protected at the regulated insurer subs.
AIG is like a fine hotel chain whose idiot heirs lost the deed at Monte Carlo. No displaced guests, just a gambling debt.
By , at
Sat Mar 07, 07:49:00 AM:
TH:
Doesn't it seem silly to excoriate trading on bad news when we rarely consider trading restrictions on good news? Do we live in a Lake-Wobegon world where all news about companies is above-average?
By , at
Sat Mar 07, 08:11:00 AM:
Trouble with short-selling is the lack of disclosure. Our securities regulation works pretty well when it's based on requiring meaningful disclosure, not prohibiting conduct.
If someone has to report a big buy, why not a big short. London is now requiring this.
Also, credit default swap market is totally unregulated and not transparent. Companies like Bear Stearns apparently were attacked by sharks manipulating CDS pricing to create panic ... and then making their money on short positions.
Link
By 
TigerHawk, at
Sat Mar 07, 08:56:00 AM:
My only objection to the comments so far is that they treat short-selling in the abstract, good vs. evil, rather than considering the specific proposals Cramer makes: banning leveraged short funds and reinstating the uptick rule. Thinking about it since last night, I suppose my revised point of view is that I see no principled basis for banning leveraged short funds, but it seems to me that evidence is piling up that the uptick rule was stabilizing. It was in place from 1938 to 2007. We timed its abolition, which might have made sense in theory, with a huge credit implosion. Not sure that was wise.
By , at
Sat Mar 07, 10:24:00 AM:
I think that the benefits of positive and negative price signals to a market are transparent, but the trouble with short selling is the problem of the self-fulfilling prophecy. No matter how much money one spends pumping up a stock, the revenue streams and ROIs will betray whether that stock is worthwhile in the lnog run; what goes up must either deserve it or revert to the mean. Short selling, on the other hand, can literally break a company; depress its share price, sow panic, and cut the credit lines that keep the company alive from a cashflow standpoint. This obviously creates perverse incentives, because any entity with sufficient market power can break a company. (These actors do exist, making theoretical economics an approximation rather than solution.) We forbid market manipulation in other circumstances, such as buying up the futures stack of a commodity and dumping it all right before maturity, (see: Amaranth) so a mitigation of perverse market power seems reasonable here. Additionally, not that the "snap a stock" strategy is most effective exactly when we don;t want it to be: when fear and uncertainty increase volatility anyway. Proposed solutions: the uptick rule, and a ban on naked shorting. If you are required to secure an agreement to borrow a stock in order to short, when holders fear downturns they will hold the stock to sell themselves (rather than receive a worthless asset later). More generally I think that the major exchanges need a consistent market-power-mitigation rule, but that's another story.
By zedman, at
Sat Mar 07, 01:15:00 PM:
He mentions Citi, JPM and Wells Fargo. What he doesn't mention is that the short interest in all of these stocks is less than a single day's trading volume. Does such a small minority really drive these stocks down without any fundamental reasons why the stocks have fallen. The stocks have fallen because people don't believe in them. There are more long investors selling than long buyers believing they are bargains. Supply exceeds demand = prices fall.
By , at
Sun Mar 08, 06:29:00 AM:
Is not the uptick rule the Evil Twin of leverage?
Leverage is oh-so-profitable on the way up, and oh-so-ruinous on the way down.
The uptick rule is oh-so-nice for slowing contractions. But if history teaches us that it is impossible to *prevent* bubbles, is not the key to limiting bubbles' destructive effects, popping them early, while they're still small? And does not the uptick rule tend to reduce short-sellers' ability to pop bubbles early?
Seems to me the lesson of Long Term Capital Management (and Amaranth, and ...) is that *leverage* is the fundamental problem. High leverage is profoundly pro-cyclical: it amplifies both the upswings and the downswings.
Are not naked short-selling and naked credit-default-swapping just forms of speculating at high leverage?
