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When you're selling something you don't own you're distorting the market's price discovery mechanisms. In many contexts I think most people would consider it fr

by Yrlec 14y ago

When you're selling something you don't own you're distorting the market's price discovery mechanisms. In many contexts I think most people would consider it fraudulent to sell something before you've bought it.

impldefined 14y ago
But doesn't there need to be a way to bet that something is overpriced?
cynicalkane 14y ago
I've never got the impression that most economists think short selling distorts the market's price discovery mechanisms, and it's really dishearting that the GP is being downvoted for, plainly and clearly, stating what is economic orthodoxy. Anyway, the futures market has functioned for centuries with people buying and selling what they don't own, and the big institutional buyers and sellers commonly use futures prices as their benchmark prices. It looks like the smart money isn't too concerned about negative effects on price discovery. Also, let's not confuse playing by the clearly established rules of the market with "fraud". Moral objection is no excuse for equivocation.
- Yrlec 14y ago
  Normal short selling doesn't distort price discovery. Khan Academy describes this quite well: http://www.youtube.com/watch?v=zAkMhEqWFF0 http://www.youtube.com/watch?v=zAkMhEqWFF0. However, with naked short selling it's a different story. When you're short selling something that you don't own you're in effect making it look like the supply is bigger than it actually is. This distorts the price discovery mechanism.
  - cynicalkane 14y ago
    Naked short interest is almost certainly too ephermal to distort the price, but suppose it does due to illusory oversupply. So what's the objection? If you buy, hold, and sell, you want prices to be overall lower. Selling low isn't bad if it means you were also buying low. In short, as Warren Buffet likes to point out, low prices are good for investors.
- Symmetry 14y ago
  In the futures market the items traded are accurately described as futures, rather than the seller pretending that they have the item they're selling.
  - cynicalkane 14y ago
    For Pete's sake, it's the rules of the game. You might have an objection to naked shorting. but you can't redefine naked shorting as "pretending" because you don't like the rules. They're not pretending to follow the rules of the market, they are actually following the rules of the market. Having actual posession of the item at the precise moment of sale is not a rule of the market in question. Lay investors still get their shares delivered, so I have no idea what you're worrying about.
    - p0ckets 14y ago
      No. If someone bought all the traded shares of overstock.com at a particular point in time, they would've bought 107% of the available shares. So it would be impossible for all their shares to get delivered.
      - quantgenius 14y ago
        Generally, if short interest gets very high many, many professional investors get interested in buying the stock for precisely that reason. Buy enough and recall your stock, ie make it not available for borrow and you create a short squeeze sending the price into the stratosphere and then you can sell into the squeeze making a tidy profit. If you are short and your stock gets recalled you could theoretically lose your entire net worth. Something similar actually happened in Germany with Porsche trading VW stock and VW shorts getting killed during the financial crisis. The fact that no one was willing to do that to OSTK stock tells you how shitty the company is and how overvalued the stock was.
      - cynicalkane 14y ago
        You're worried about a guy at a brokerage buying 107% of all traded shares of a company?
roel_v 14y ago
"When you're selling something you don't own you're distorting the market's price discovery mechanisms." How? It only does so if one sets out to do it on purpose, and in that case there is no difference between selling something that own, or that you don't (yet) own. Let's say I sell grain to you for 300 USD per ton, to be delivered in Fall 2012. How does that distort the market? Alternatively, how is this example different from naked selling? Or isn't it, and do you think that this sort of insurances should be prohibited too? "In many contexts I think most people would consider it fraudulent to sell something before you've bought it." I'm not sure. There are many retailers who only order something from their wholesaler or manufacturer after you've bought it from them. Why would a buyer be concerned with when or how a seller gets his merchandise? It only becomes a problem after failing to deliver the goods, and when no adequate compensation for such a failure can be given (i.e., a seller going bankrupt because of a naked sale gone wrong). Something that could be controlled, regulated or mitigated in many ways that are much less intrusive than forbidding 'naked shorts'.
- cgmorton 14y ago
  I think the confusion here is that 'short selling' is a misnomer - it doesn't involve any merchandise at all. From the article: "In other words, 107% of all Overstock shares available for trade were short – a physical impossibility, unless someone was somehow creating artificial supply in the stock." That is to say, there were more Overstock shares in the market than actually existed, because they were borrowed from thin air. With a retailer, the merchandise will get delivered, and then the buyers will have it forever. With 'naked shorting', the merchandise is created from nowhere, lent out, sold, rebought, returned, and then disappeared. The shares never actually exist. But they affect the market as if they do exist - e.g. more shares existing in a company means every share is less valuable, so by magicking these shares into existence the price is equally magically dropped, which helps makes the shorting auto-succeed. It is straight up cheating. Imagine a grain holding company lends you some paper 'shares' that are stand-ins for X amount of grain. It produces many of these shares, flooding the market with 'grain', and as a result the price falls. At this point their lenders buy up the grain from grain farmers at these lower prices, thus making a profit, and then return the grain to the company who then hands it out to the people who bought the shares. In this way, the grain farmers lose money because their product is devalued, while the company and its investors make money. This is the only mechanic at play: money flowing from the people who create value into the pockets of the market manipulators. Oh, and this 'grain holding company'? They never had any grain to begin with. All they had was the know-how and connections to lie and get away with it.
anamax 14y ago
How is "naked short selling" of stock any different from selling corn that hasn't been grown yet? Or, taking out a construction loan. etc. There are lots of "don't have it yet" processes. Consider the typical loan. The borrower typically doesn't have the money at the time that the loan is made.
quantgenius 14y ago
What about when a manufacturer sells something they haven't manufactured yet under a contract to deliver a few days into the future based on a reasonable expectation that the inputs into the manufacturing process are widely available at reasonable prices and they have the technology etc necessary to manufacture what they are selling? Is just in time manufacturing fraudulent?

by Yrlec 14y ago

impldefined 14y ago

But doesn't there need to be a way to bet that something is overpriced?

cynicalkane 14y ago

I've never got the impression that most economists think short selling distorts the market's price discovery mechanisms, and it's really dishearting that the GP is being downvoted for, plainly and clearly, stating what is economic orthodoxy. Anyway, the futures market has functioned for centuries with people buying and selling what they don't own, and the big institutional buyers and sellers commonly use futures prices as their benchmark prices. It looks like the smart money isn't too concerned about negative effects on price discovery. Also, let's not confuse playing by the clearly established rules of the market with "fraud". Moral objection is no excuse for equivocation.

Yrlec 14y ago
Normal short selling doesn't distort price discovery. Khan Academy describes this quite well: http://www.youtube.com/watch?v=zAkMhEqWFF0 http://www.youtube.com/watch?v=zAkMhEqWFF0. However, with naked short selling it's a different story. When you're short selling something that you don't own you're in effect making it look like the supply is bigger than it actually is. This distorts the price discovery mechanism.
- cynicalkane 14y ago
  Naked short interest is almost certainly too ephermal to distort the price, but suppose it does due to illusory oversupply. So what's the objection? If you buy, hold, and sell, you want prices to be overall lower. Selling low isn't bad if it means you were also buying low. In short, as Warren Buffet likes to point out, low prices are good for investors.
Symmetry 14y ago
In the futures market the items traded are accurately described as futures, rather than the seller pretending that they have the item they're selling.
- cynicalkane 14y ago
  For Pete's sake, it's the rules of the game. You might have an objection to naked shorting. but you can't redefine naked shorting as "pretending" because you don't like the rules. They're not pretending to follow the rules of the market, they are actually following the rules of the market. Having actual posession of the item at the precise moment of sale is not a rule of the market in question. Lay investors still get their shares delivered, so I have no idea what you're worrying about.
  - p0ckets 14y ago
    No. If someone bought all the traded shares of overstock.com at a particular point in time, they would've bought 107% of the available shares. So it would be impossible for all their shares to get delivered.
    - quantgenius 14y ago
      Generally, if short interest gets very high many, many professional investors get interested in buying the stock for precisely that reason. Buy enough and recall your stock, ie make it not available for borrow and you create a short squeeze sending the price into the stratosphere and then you can sell into the squeeze making a tidy profit. If you are short and your stock gets recalled you could theoretically lose your entire net worth. Something similar actually happened in Germany with Porsche trading VW stock and VW shorts getting killed during the financial crisis. The fact that no one was willing to do that to OSTK stock tells you how shitty the company is and how overvalued the stock was.
    - cynicalkane 14y ago
      You're worried about a guy at a brokerage buying 107% of all traded shares of a company?

roel_v 14y ago

"When you're selling something you don't own you're distorting the market's price discovery mechanisms." How? It only does so if one sets out to do it on purpose, and in that case there is no difference between selling something that own, or that you don't (yet) own. Let's say I sell grain to you for 300 USD per ton, to be delivered in Fall 2012. How does that distort the market? Alternatively, how is this example different from naked selling? Or isn't it, and do you think that this sort of insurances should be prohibited too? "In many contexts I think most people would consider it fraudulent to sell something before you've bought it." I'm not sure. There are many retailers who only order something from their wholesaler or manufacturer after you've bought it from them. Why would a buyer be concerned with when or how a seller gets his merchandise? It only becomes a problem after failing to deliver the goods, and when no adequate compensation for such a failure can be given (i.e., a seller going bankrupt because of a naked sale gone wrong). Something that could be controlled, regulated or mitigated in many ways that are much less intrusive than forbidding 'naked shorts'.

cgmorton 14y ago
I think the confusion here is that 'short selling' is a misnomer - it doesn't involve any merchandise at all. From the article: "In other words, 107% of all Overstock shares available for trade were short – a physical impossibility, unless someone was somehow creating artificial supply in the stock." That is to say, there were more Overstock shares in the market than actually existed, because they were borrowed from thin air. With a retailer, the merchandise will get delivered, and then the buyers will have it forever. With 'naked shorting', the merchandise is created from nowhere, lent out, sold, rebought, returned, and then disappeared. The shares never actually exist. But they affect the market as if they do exist - e.g. more shares existing in a company means every share is less valuable, so by magicking these shares into existence the price is equally magically dropped, which helps makes the shorting auto-succeed. It is straight up cheating. Imagine a grain holding company lends you some paper 'shares' that are stand-ins for X amount of grain. It produces many of these shares, flooding the market with 'grain', and as a result the price falls. At this point their lenders buy up the grain from grain farmers at these lower prices, thus making a profit, and then return the grain to the company who then hands it out to the people who bought the shares. In this way, the grain farmers lose money because their product is devalued, while the company and its investors make money. This is the only mechanic at play: money flowing from the people who create value into the pockets of the market manipulators. Oh, and this 'grain holding company'? They never had any grain to begin with. All they had was the know-how and connections to lie and get away with it.

anamax 14y ago

How is "naked short selling" of stock any different from selling corn that hasn't been grown yet? Or, taking out a construction loan. etc. There are lots of "don't have it yet" processes. Consider the typical loan. The borrower typically doesn't have the money at the time that the loan is made.

quantgenius 14y ago

What about when a manufacturer sells something they haven't manufactured yet under a contract to deliver a few days into the future based on a reasonable expectation that the inputs into the manufacturing process are widely available at reasonable prices and they have the technology etc necessary to manufacture what they are selling? Is just in time manufacturing fraudulent?