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> All these articles about naked short selling seem to be missing a simple point: Alice owns 100 shares of some stock. She lends them to short seller Bob who s

> All these articles about naked short selling seem to be missing a simple point: Alice owns 100 shares of some stock. She lends them to short seller Bob who sells them to Carmen. Carmen now owns 100 shares, which she lends to short seller Dan, who in turn sells them to Esther. Esther lends her 100 shares to short seller Fred who sells them to Gloria. At this point, the short interest in the stock is 300 shares (Bob, Dan and Fred sold short) but it's only Alice's 100 shares that made the rounds. And nobody broke any rules. In other words: 1. Alice owns 100 shares 2. When Alice lends them to short seller Bob, Alice no longer owns 100 shares. She owns an IOU from Bob, and Bob owns the shares. 3. Then Carmen owns 100 shares. 4. When Carmen lends the shares to short seller Dan, Carmen no longer owns 100 shares. She owns an IOU from Dan, and Dan owns the shares. 5. ... At the end of the cycle, Alice owns 100 IOU from Bob, Carmen owns 100 IOU from Dan, Esther owns 100 IOU from Fred and only Gloria owns 100 shares. It's basically fractional reserve, for shares. If Bob goes under Alice owns nothing.

HenryBemis 6y ago
Now to see the insanity of the A-->B-->C-->D-->D-->E-->F setup: how can I lend you a chair, it goes from hand to hand from A to F, and at the same time I still have it on my patio? Stocks used to be pieces of papers. In the goold old days, in the end of the day people were spending hours moving papers "stocks" around from your account to my account (literally, papers)(https://duckduckgo.com/?q=paper+stock+certificates&t=ffab&iar=images&iax=images&ia=images https://duckduckgo.com/?q=paper+stock+certificates&t=ffab&ia...) I know that the big players are adding iterations, complexity (and other similar words) only so they can repack "the thing" re-sell it to someone. It's like derivatives in mathimatics. You raise, and you raise, and you raise, and you raise, and you... kinda like the movie Inception. (I apologise if I got the wrong math term.. it's been 'a while'). Edit: OP deleted his/her comment while Throw and I were drafting ours.
- qeternity 6y ago
  > Now to see the insanity of the A-->B-->C-->D-->D-->E-->F setup: how can I lend you a chair, it goes from hand to hand from A to F, and at the same time I still have it on my patio? Securities only have utility when you sell them. It’s more like having a chair in your garage that you’re not using, and lending it to your neighbor. Do you still own a chair? Yes. Does your neighbor have a chair? Yes. When you want the chair back you simply ask for it back, and your neighbor can either borrow a chair from someone else or buy their own.
  - andi999 6y ago
    The danger with stocks is they are all the same (from the same company). Nobody would think of selling the chair they borrowed from the neighbor (if they want to stay friendly with the neighbour). Maybe it is more like eggs. You ask you neighbour for a few eggs, and later give them back (but everybody understands them to be different eggs)
    - exporectomy 6y ago
      People do that with money. "Can I borrow $20 to pay the rent? I'll pay you back next week, I promise."
- thaumasiotes 6y ago
  > Now to see the insanity of the A-->B-->C-->D-->D-->E-->F setup: how can I lend you a chair, it goes from hand to hand from A to F, and at the same time I still have it on my patio? You don't. Nobody claims you do, not even in the short-selling situation you're trying to describe; you can't vote a share that you've lent out. > Stocks used to be pieces of papers. In the goold old days, in the end of the day people were spending hours moving papers "stocks" around from your account to my account (literally, papers) This didn't change; it's just that, under US law, you can no longer own any stock. (Well, more specifically, you can't own stock that you buy on a stock exchange.) Instead, there is a company that exists solely for the purpose of owning all the stock and registering your interest in it. When you sell a stock to someone else, DTCC owns that stock before and after you sell it; what changes is that their internal records may or may not update the name under which that stock is registered. There's a fun paper here ( https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017206 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017206 ) going over the history: > Congress, in the 1975 Securities Acts Amendments, took the extremely unusual step of legally imposing a single technique for settlement on the markets. The effect on securities settlement was somewhat comparable the effects of a law that would require all computers plugged into the internet to run on DOS.
- hntrader 6y ago
  Chairs aren't a fungible commodity and chairs depreciate, which are the two reasons you can't short chairs. If chairs were fungible and didn't depreciate, then they would be shortable just like stocks, but you wouldn't be able to keep it yourself, you'd need to loan it out to be short-sold by someone else.
  - lupire 6y ago
    The concept of a commodity fails when it's controlled by a cartel or can't be produced in sufficient volume to meet demand, as seen with oil and short squeezes.
    - hntrader 6y ago
      I'm not attempting to make a value judgement about one commodity vs another, I'm just outlining what is the necessary and sufficient condition for something to be short-able, which I think is widely misunderstood (I say this because of Elon's tweets that "we can't short cars"). Cars, chairs, etc, can't be shorted, since they aren't fungible. This reason is mostly a practical one. If people really wanted to short cars, despite the fact that they aren't fungible, they would be able to, they just need to prepare the necessary legal paperwork. Nobody does this because it would be extremely annoying to do so, and for very little benefit. Things that are fungible can be shorted easily with minimal legal legwork. Stocks are fungible and therefore can be shorted. Now regarding the supply of a commodity that's available to short, in the case of stocks that's determined by the executive team and board when there's a need to raise funds. I wouldn't exactly call that a cartel. They're just doing what they think is best for their business (i.e., issuing new stock when the company needs funds and they don't wish to raise through debt).
toast0 6y ago
> If Bob goes under Alice owns nothing. Which is why Alice requires good collateral of from Bob before agreeing to loan the shares; generally cash or treasuries of equal value to the shares, marked to market daily. If Bob goes under, Alice has Bob's collateral.
CTDOCodebases 6y ago
What if all this trading occurred within a two day timeframe then at the end of the two day settlement period Alice’s stockbroker doesn’t deliver Alice’s shares? What happens then?
- Judgmentality 6y ago
  It's called a failed to deliver. It happens all the time. It's bullshit, but there are millions of FTDs on GME.
Traster 6y ago
This is categorically not like fractional reserve. The whole point of fractional reserve is the bank can lend out a multiple of its deposits- hence fractional. In this situation no one is lending anything they don’t have. This is just like the difference between GDP and money supply. GDP is the rate at which money is changing hands, which can be many multiples of the money supply for perfectly valid reasons. Similarly this situation did change the actual supply of stock it just increased the rate of movement.
- lupire 6y ago
  Fraction is less than 1. Multiple is more than 1. You are describing negative fractonal reserve.
  - Traster 6y ago
    I wouldn't have thought I would have to explain this on hacker news but if you're lending a multiple of the deposit than you have fractional reserve. (which is not the same thing as lending the actually number of shares you have ownership of)
michaelscott 6y ago
A good summary of the situation, although it's not really fractional reserve. The problem is that in any report of short interest Alice is not shown to have that IOU but rather her original 100 shares (in addition to Bob's). I understand the term short interest is appropriate because it reflects the consensus of bearish sentiment better, but it only works if the IOUs flying around can be backed by money (i.e. don't require settlement in the original shares). In the event that large amounts of the stock are bought, held and refuse to be sold to cover short positions the entire chain can collapse to Alice sells 100 shares to Gloria and the rest either suffer heavy losses or go completely bankrupt.
- lupire 6y ago
  It's basically the same as a bank run, where you ask for your money back but it's not actually there. But it's leveraged because it's stock not money and the stock is comtroled by a cartel; you cants make some to settle your debt.
cm2187 6y ago
It’s not really an IOU. It is collateralised, so the risk to Alice in theory is much smaller. The collateral is typically adjusted daily, so technically there is still a residual risk if there was a large intra day movement. But I wouldn’t think of it as a bank loan.
delaaxe 6y ago
All of this doesn't address the concept of naked short selling in the post's title. Naked short selling happens when Bob sells short 100 shares without having borrowed them from anyone beforehand, effectively conjuring new shares out of thin air. Certain market participants are allowed to do this for "liquidity purposes"
- JackFr 6y ago
  So as the buyer opposite the short, in such a case, what do I have in my account? It’s not thin air.
  - otherme123 6y ago
    You have the right to receive a share, as soon as it is available in the market. They have 2 days to fullfil your account, or they issue a "fail to deliver". Naked shorts are allowed to market-makers, because if when you buy there's no counterpart but it's reasonably expected, you receive this "right to a real share" to be filled with a real share as soon as the market-market can buy a real one. You'll never notice however. This mechanism works like oil in an engine and is almost neutral to the market dynamics, and they receive a fee to keep the engine oiled. The problem is when market-makers abuse this ability, and shorting nakedly too much sends wrong signals to the market, pushing it down and self-fullfilling the profecy. In the same way that pump-and-dump is illegal, this works in reverse (short-and-distort).
    - lupire 6y ago
      Short and distort is separate from naked shorting. Excess Naked shorting is just fraud to amplify the scheme.
    - lokar 6y ago
      People just don't understand how the market works. When you click sell and get back a confirmation you have not sold. You have agreed to sell, in two days.
  - delaaxe 6y ago

HenryBemis 6y ago

Now to see the insanity of the A-->B-->C-->D-->D-->E-->F setup: how can I lend you a chair, it goes from hand to hand from A to F, and at the same time I still have it on my patio? Stocks used to be pieces of papers. In the goold old days, in the end of the day people were spending hours moving papers "stocks" around from your account to my account (literally, papers)(https://duckduckgo.com/?q=paper+stock+certificates&t=ffab&iar=images&iax=images&ia=images https://duckduckgo.com/?q=paper+stock+certificates&t=ffab&ia...) I know that the big players are adding iterations, complexity (and other similar words) only so they can repack "the thing" re-sell it to someone. It's like derivatives in mathimatics. You raise, and you raise, and you raise, and you raise, and you... kinda like the movie Inception. (I apologise if I got the wrong math term.. it's been 'a while'). Edit: OP deleted his/her comment while Throw and I were drafting ours.

qeternity 6y ago
> Now to see the insanity of the A-->B-->C-->D-->D-->E-->F setup: how can I lend you a chair, it goes from hand to hand from A to F, and at the same time I still have it on my patio? Securities only have utility when you sell them. It’s more like having a chair in your garage that you’re not using, and lending it to your neighbor. Do you still own a chair? Yes. Does your neighbor have a chair? Yes. When you want the chair back you simply ask for it back, and your neighbor can either borrow a chair from someone else or buy their own.
- andi999 6y ago
  The danger with stocks is they are all the same (from the same company). Nobody would think of selling the chair they borrowed from the neighbor (if they want to stay friendly with the neighbour). Maybe it is more like eggs. You ask you neighbour for a few eggs, and later give them back (but everybody understands them to be different eggs)
  - exporectomy 6y ago
    People do that with money. "Can I borrow $20 to pay the rent? I'll pay you back next week, I promise."
thaumasiotes 6y ago
> Now to see the insanity of the A-->B-->C-->D-->D-->E-->F setup: how can I lend you a chair, it goes from hand to hand from A to F, and at the same time I still have it on my patio? You don't. Nobody claims you do, not even in the short-selling situation you're trying to describe; you can't vote a share that you've lent out. > Stocks used to be pieces of papers. In the goold old days, in the end of the day people were spending hours moving papers "stocks" around from your account to my account (literally, papers) This didn't change; it's just that, under US law, you can no longer own any stock. (Well, more specifically, you can't own stock that you buy on a stock exchange.) Instead, there is a company that exists solely for the purpose of owning all the stock and registering your interest in it. When you sell a stock to someone else, DTCC owns that stock before and after you sell it; what changes is that their internal records may or may not update the name under which that stock is registered. There's a fun paper here ( https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017206 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017206 ) going over the history: > Congress, in the 1975 Securities Acts Amendments, took the extremely unusual step of legally imposing a single technique for settlement on the markets. The effect on securities settlement was somewhat comparable the effects of a law that would require all computers plugged into the internet to run on DOS.
hntrader 6y ago
Chairs aren't a fungible commodity and chairs depreciate, which are the two reasons you can't short chairs. If chairs were fungible and didn't depreciate, then they would be shortable just like stocks, but you wouldn't be able to keep it yourself, you'd need to loan it out to be short-sold by someone else.
- lupire 6y ago
  The concept of a commodity fails when it's controlled by a cartel or can't be produced in sufficient volume to meet demand, as seen with oil and short squeezes.
  - hntrader 6y ago
    I'm not attempting to make a value judgement about one commodity vs another, I'm just outlining what is the necessary and sufficient condition for something to be short-able, which I think is widely misunderstood (I say this because of Elon's tweets that "we can't short cars"). Cars, chairs, etc, can't be shorted, since they aren't fungible. This reason is mostly a practical one. If people really wanted to short cars, despite the fact that they aren't fungible, they would be able to, they just need to prepare the necessary legal paperwork. Nobody does this because it would be extremely annoying to do so, and for very little benefit. Things that are fungible can be shorted easily with minimal legal legwork. Stocks are fungible and therefore can be shorted. Now regarding the supply of a commodity that's available to short, in the case of stocks that's determined by the executive team and board when there's a need to raise funds. I wouldn't exactly call that a cartel. They're just doing what they think is best for their business (i.e., issuing new stock when the company needs funds and they don't wish to raise through debt).

toast0 6y ago

> If Bob goes under Alice owns nothing. Which is why Alice requires good collateral of from Bob before agreeing to loan the shares; generally cash or treasuries of equal value to the shares, marked to market daily. If Bob goes under, Alice has Bob's collateral.

CTDOCodebases 6y ago

What if all this trading occurred within a two day timeframe then at the end of the two day settlement period Alice’s stockbroker doesn’t deliver Alice’s shares? What happens then?

Judgmentality 6y ago
It's called a failed to deliver. It happens all the time. It's bullshit, but there are millions of FTDs on GME.

Traster 6y ago

This is categorically not like fractional reserve. The whole point of fractional reserve is the bank can lend out a multiple of its deposits- hence fractional. In this situation no one is lending anything they don’t have. This is just like the difference between GDP and money supply. GDP is the rate at which money is changing hands, which can be many multiples of the money supply for perfectly valid reasons. Similarly this situation did change the actual supply of stock it just increased the rate of movement.

lupire 6y ago
Fraction is less than 1. Multiple is more than 1. You are describing negative fractonal reserve.
- Traster 6y ago
  I wouldn't have thought I would have to explain this on hacker news but if you're lending a multiple of the deposit than you have fractional reserve. (which is not the same thing as lending the actually number of shares you have ownership of)

michaelscott 6y ago

A good summary of the situation, although it's not really fractional reserve. The problem is that in any report of short interest Alice is not shown to have that IOU but rather her original 100 shares (in addition to Bob's). I understand the term short interest is appropriate because it reflects the consensus of bearish sentiment better, but it only works if the IOUs flying around can be backed by money (i.e. don't require settlement in the original shares). In the event that large amounts of the stock are bought, held and refuse to be sold to cover short positions the entire chain can collapse to Alice sells 100 shares to Gloria and the rest either suffer heavy losses or go completely bankrupt.

lupire 6y ago
It's basically the same as a bank run, where you ask for your money back but it's not actually there. But it's leveraged because it's stock not money and the stock is comtroled by a cartel; you cants make some to settle your debt.

cm2187 6y ago

It’s not really an IOU. It is collateralised, so the risk to Alice in theory is much smaller. The collateral is typically adjusted daily, so technically there is still a residual risk if there was a large intra day movement. But I wouldn’t think of it as a bank loan.

delaaxe 6y ago

All of this doesn't address the concept of naked short selling in the post's title. Naked short selling happens when Bob sells short 100 shares without having borrowed them from anyone beforehand, effectively conjuring new shares out of thin air. Certain market participants are allowed to do this for "liquidity purposes"

JackFr 6y ago
So as the buyer opposite the short, in such a case, what do I have in my account? It’s not thin air.
- otherme123 6y ago
  You have the right to receive a share, as soon as it is available in the market. They have 2 days to fullfil your account, or they issue a "fail to deliver". Naked shorts are allowed to market-makers, because if when you buy there's no counterpart but it's reasonably expected, you receive this "right to a real share" to be filled with a real share as soon as the market-market can buy a real one. You'll never notice however. This mechanism works like oil in an engine and is almost neutral to the market dynamics, and they receive a fee to keep the engine oiled. The problem is when market-makers abuse this ability, and shorting nakedly too much sends wrong signals to the market, pushing it down and self-fullfilling the profecy. In the same way that pump-and-dump is illegal, this works in reverse (short-and-distort).
  - lupire 6y ago
    Short and distort is separate from naked shorting. Excess Naked shorting is just fraud to amplify the scheme.
  - lokar 6y ago
    People just don't understand how the market works. When you click sell and get back a confirmation you have not sold. You have agreed to sell, in two days.
- delaaxe 6y ago