Tim Worstall provides a suitably terse response to the latest piece of economic illiteracy from leftie writer Richard Murphy, who is against admirable things like avoidance of high taxes, and who now is supporting measures to prevent, or at least hamper, investors from making money by “shorting” the shares of firms they think are likely to perform badly.
The practice of “shorting” seems to get a certain class of person all upset. Earlier this year, when the shares of HBOS, the UK banking group, came under pressure, the cry went up that those irresponsible wreckers called hedge funds were deliberately trying to destroy the firm to make a fast profit. What this ignores is that if there were not investors willing to temporarily borrow stock as part of their short-selling tactics, then this would reduce the total number of counterparties in a market, and reduce liquidity and efficiency in the pricing of shares, which is a bad thing. Illiquid markets – which can produce big jumps up or down in the prices of shares – are generally not good places to be in, particularly for smaller investors.
If I take a dim view of a company that I do not own, shorting lets me act on that view and maybe make some money out of it. Quite why this is so terrible, Mr Murphy does not bother to explain.
Some time ago, when I wrote about this topic, one sarcastic commenter moaned that I was insulting the intelligence of readers by trying to explain what “shorting” is. I reject that criticism since it s plainly obvious that even among supposedly intelligent people, the workings of the financial markets are mysterious. And what people do not understand, they fear.
I suspect the objection that lefties have to short-selling has the same heart as their objection to all speculation (“speculation” being deemed by them to have highly pejorative connotations), and in fact it is an objection to all markets. They object to the idea that a price is a subjective judgment by both buyer and seller, and that people choose to exchange based on their own estimation that they will be better off than otherwise as a result.
If you believe there is, or ought to be, an ascertainable “true” value of things, then of course trade based on each side thinking himself better off is impossible. So the lefty assumes that people should trade only out of necessity or altruism, and if they don’t then they are motivated by larceny. Which is why they are more outraged by financial and futures markets than others – because they can’t see any ‘necessary’ goods and services flowing to serve basic physical desires directly. It is also responsible for the poisonous Greenie hatred of growing cash-crops for world markets, as opposed to the ‘sustainable’ practice of growing only what you can eat in your village, and starving to death when you have a bad harvest.
Accountants, unfortunately, have to use the historical cost system. So there *is* an ascertainably true value of things, even if it’s only a legal fiction.
Which, come to think of it, companies are too.
But short-selling, like most other investment methods, should be perfectly legal. Including futures and options, which kinda suck.
Including futures and options, which kinda suck.
Why do they “suck”? Without such markets, it would be next to impossible for people to hedge against adverse moves in prices of things. The ancient Greeks started what we would now call futures markets in olive oil, so that a farmer could be paid up-front an agreed amount for his crop even before he had harvested it. The great futures and options markets in Chicago started in the 19th century so that farmers could get some certainty about the prices paid for their crops.
Such things do not “suck” at all; they are part of the way in which the differing appetites for financial risk play out in a market place.
Usual sweeping generalisations about the left I see – read Chris Dillow(Link) on the same topic a week ago.
Ian, yes, it is a “seeping generalisation”; what, you going to start claiming that large chunks of the left are fans of financial speculation? That should be quite a revelation to me, I must say.
Then again, “left” for me is short-hand for “anti-market”, which can include quite a large field.
A very minor point I know but …
I find it odd that you would be criticised for defining your terms. One of the problems I have reading the financial press is the failure of many articles to do so.
So well done to you sir.
One is reminded of the comment in one of Hayek’s essays about the lack of public understanding that in the “dark” ages, smelters and blacksmiths activities were confined to outside the villages, being suspect of witchcraft or sorcery in being able to make something of nothing by fires and “dirt.”
It is not only the left that believes the future can be directed by careful ‘expert’ (themselves) planning. And if you claim you are an expert and can direct the future, it is essential to suppress criticism from other ‘experts’ right or wrong.
The futures markets and all forms of futures speculation are a feedback cycle, driven by people directly or indirectly risking their own money, not ‘the public’s’ or the shareholder’s. Consequently, all professional planners, government and corporate, greatly fear and will always attempt to eradicate them. They even make stockpiling and saving a pejorative by call it ‘hoarding’. These things strip the masking robes off of duplicitious promises.
I think the problem with HBOS was not the short selling specifically, but the spreading of rumours that the bank was in a drastic state and ready to collapse combined with short selling as appropriate.
The entry you refer to is crap of course, but the actual problem that manifested itself was nonetheless real – huge spikes and dips in the share price on an hourly basis.
Whether that is a ‘real’ problem remains to be seen.
The ‘left’ is no more uniform and consistent than the ‘right’ or ‘libertarians’.
As for anti-market, are you trying to argue that large chunks of the ‘right’ are in favour of a genuinely free market. I don’t see the evidence for that. Even that alleged paragon of free enterprise, Margaret Thatcher only fiddled around the edges. I didn’t get a free choice of who emptied my bin – all that happened was she forced me to use a different monopoly provider.
Sorry – directed to Johnathon at 11.36 above.
Ian, who seems a bit upset by my comments, writes this:
That is half-correct; one reason why I prefer to call myself a libertarian than right wing is precisely because I find the former term more exact than the latter. A lot of people who call themselves right wing are, true, inconsistent in their support for markets, but I would argue that leftists are rarely given to support markets, although there are exceptions, such as Chris Dillow. But he is rare. You cannot really deny that. Take any random selection of people who call themselves “left” and then ask them what they think of hedge funds or whatever. Then tell me that what I wrote was a “sweeping generalisation”.
Anyway, generalisations have their uses. They are usually based on a kernal of truth.
“who now is supporting measures to prevent, or at least hamper, investors from making money by “shorting” the shares of firms they think are likely to perform badly”
Why not go all the way, and ban people from deciding not to buy shares in businesses they think will do badly, too? In fact, if we made a law that said every share price had to be over £10,000,000, we’d all be rich and no business would ever fail, right?! Or would that just prevent people from valuing the business as according to its real earning potential and survivability? Make your own mind up on that one…
Dear JP;
That was a personal opinion. I certainly hope I don’t have to make that disclaimer everytime I post something *clearly* non-factual. I mean, come on, the very term ‘kinda suck’ is so vague it can only be an opinion – especially when speaking about financial instruments, which have valuation curves, ROE, ROI and all that other stuff I slept my way through in uni. I believe they suck because I don’t like my predictions of the future to determine the future itself. I like old, stodgy, semi-based-on-current-objective-reality-by-my-definition investment and financial vehicles such as shares and fixed deposits; even mutual funds.
YMMV, and I don’t care. Like I said, they should all remain legal, even if their sucktitude level is too high for me.
You can, of course, attempt to persuade me otherwise. But is that really a wise use of your limited resources? 🙂 Considering that I would hardly be in a position to influence the matter one way or the other, I mean?
ian,
As for anti-market, are you trying to argue that large chunks of the ‘right’ are in favour of a genuinely free market. I don’t see the evidence for that. Even that alleged paragon of free enterprise, Margaret Thatcher only fiddled around the edges. I didn’t get a free choice of who emptied my bin – all that happened was she forced me to use a different monopoly provider.
I agree wholeheartedly with that. A lot more difficult to find enthusiasm for the free market – that’s “free” as well as “market” – on the left, though.
This is because the basis of a real market (as opposed to an “internal market” – what Ludwig Von Mises discribed as “playing with toy trains in your attic, whilst thinking you are running a real railway company”) is based on private property.
And the rights of private property are exactly what the left is against.
The abuse of something is no argument against its proper use. The proper use of a short sale is to exchange risk and value between two investors who weigh them differently.
However, short sales can be a sign of abuse. If an investor has sufficient power to reduce the price of the security he has sold short, he can rob not only the purchaser he deals with but also all other shareholders. In the USA it’s illegal for corporate insiders to do this or even to make use of private information. Large shareholders cannot legally “pump and dump” to manipulate the price of a stock they have sold short. But, it is perfectly legal for a lawyer to sell a security short or buy a put option in it, then file a lawsuit against the company which drives down its stock price. Libertarians may object to regulation of financial markets as a matter of principle but those regulations are usually enacted after abuses have become obvious.
The left get upset about shorting not because people are taking dim views of businesses, but because the profit from shorting ends up in the private sector. The left take all sorts of dim views of business (regulation, “windfall” taxes, etc), but their dim views are virtuous because the spoils from their dim views end up in the greedy maw of Big Government.
Jack Olsen, Spot on. A market for short interest itself isn’t a problem at all, in fact it’s a valuable tool. Even a good thing can be bad sometimes. It’s like shooting the messenger. Shooting down an indicator just because it’s indicating something “bad” doesn’t sound like any way to address a problem.
If someone is shorting a stock they have to lock themselves into an agreement to buy the shares back at a future time. If the person or hedge fund that “shorts” a stock made the wrong bet and the stock goes up then those shorters will have to buy their shares back eventually, and will be compelled to do so if the stock looks like it will keep going up. The higher the stock goes, the more money the unsuccessful shorter will lose. The shares will get bought back, and that could very well drive the stock up and be at least a short-term positive for the company – a short squeeze.
I don’t see why the useful metrics that can be derived from a lucrative, ongoing auction should be ignored or disqualified. Rather than formulating ways to outlaw it, the British government would be better off trying to figure out why all these scary hedge funds and short sellers think that those companies are going to be losing value in the immediate future. That way they could address the root problem.
I have no fear of cricket. Thus do I refute you, sir.
Of course he doesn’t explain it; his juvenile zero-sum take on economics is so deeply ingrained that he assumes everyone shares the same understanding. To him, if one person makes wealth, it can only be because it was transferred from the pockets of someone else. Anyone who disagrees obviously does so because they are evil and greedy.
You forget this at your own peril; otherwise, people will continue to surprise you with the nonsense they come up with.
Well, if you are the kind of guy who admits to sleeping through the subject through university, and who wears his prejudices as prejudices, rather than as reasoned opinions, I obviously would not waste a lot of pixels on changing your mind. That said, when people who make comments about financial markets such as yours, even coming from someone who claims to be pro-market, the temptation for me is to give the commenter a sharp kick in the shins, without drawing too much blood, hopefully.
As any fule kno, at least any fule who has studied investment theory a bit, short positions enable portfolio managers to access more of the minimum variance set for a given rate of return than they would be able to otherwise.
There are very good reasons why most financial institutions will not let the average punter sell short. It’s very easy to get stuck on the wrong side of a margin call and watch your escrow account go pop. But investment managers need the ability to short sell in order to do their jobs. It is hard to see how restraining investors from choosing Markowitz-efficient portfolios is in anyone’s interest. Murphy has a puerile and ill-informed view of how the stock market works. No wonder his utterances on the subject are so jejune.