Sweet on Short
National Review Online, June 24, 2020
Selling a security short has rarely been a way to make friends, whether with investors, companies, regulators, or even governments. If the Fed’s job included (in more disciplined times) taking “away the punch bowl just as the party gets going,” the short seller was and is the person who tells partygoers that the punch they are so enjoying is, in fact, poison. No one wants to hear that.
Bubbles, on the other hand, whether in a stock, sector or market, are popular. And the bigger the bubble, the more popular it becomes: “Everyone” is making money, “everyone” is spending money, and governments take their slice. The boost to revenues that comes from taxing the higher salaries, the higher capital gains and the higher profits that a bubble generates can make a spendthrift government look frugal, and a careless government look wise. To be told that all this is based on a mirage, well . . .
Short selling is one way of speculating on a security’s decline: The vendor sells a (typically) borrowed security in the hope of eventually repaying that debt by later returning an equivalent security bought at a lower price. Short selling can distort the market in a security. That is why there are, for the most part rightly, so many regulations that govern the practice. Some of these rules, however, were introduced as either a panicked response to a plummeting market or as a distraction from a government’s own failings (or both). Thus, in 2010, as the euro-zone crisis worsened, Germany passed an emergency package banning certain types of short sales.
The most interesting aspect of the Reuters report describing the bans was the first half of its first sentence:
Germany, in an attack on the financial speculation on which it blames much of the euro zone’s debt crisis, [has] announced a ban on some high-risk bets that prices of bonds and stocks will fall.
The euro zone’s woes owed almost everything to the poor design and appalling management of the single currency, an exercise in central planning that was doomed, sooner or later, to run into trouble. Short sellers had nothing to do with it. But taking a run at them helped bolster the narrative peddled by Angela Merkel and other continental politicians that wicked “Anglo-Saxon” speculators were in no small part responsible for the crisis.
And how did Germany’s ban work out?
Germany’s unilateral ban on some kinds of naked short-selling failed to achieve the government’s aim of keeping asset prices from falling and succeeded only in impeding markets, the International Monetary Fund said.
“Market efficiency and quality in fact deteriorated substantially following the introduction” of short-selling bans in Germany and other European Union countries, the Washington-based IMF said in a report published yesterday and posted on the fund’s website.
The ban by Chancellor Angela Merkel’s government, issued overnight on May 19 by the BaFin financial regulator, “did relatively little to support the targeted institutions’ underlying stock prices, while liquidity dropped and volatility rose substantially,” the IMF said.
Oh.
Then again, efforts to change the subject are not confined to the other side of the Atlantic.
The New York Times, July 8, 2008:
“I will hurt the shorts, and that is my goal,” Richard Fuld Jr. fumed.
It was April, and Fuld was blaming short sellers, one of the most maligned tribes on Wall Street, for spreading rumors about Lehman Brothers, the troubled investment bank he runs. Shorts bet against stocks, and Lehman, they were whispering, looked like the next Bear Stearns.
Lehman filed for Chapter 11 bankruptcy on September 15, 2008.
Oh.
To quote one researcher from the University of Buffalo, part of a team that looked at the effect of a certain type of short selling on Lehman’s collapse (there was none that could be found), “blaming short sellers is always easier than admitting that betting the farm on subprime mortgages was a mistake.”
Ouch.
Being right is not a ticket to popularity. It is bad enough that short sellers show up at the feast, but it is even worse that they profit when the famine they have predicted duly comes to pass. They are routinely depicted as profiting from the misery of others. To take one example, the coverage of Odey Asset Management, a prominent British investment firm, which had done well — very well — out of shorting of banks in the run-up to the financial crisis, sometimes seemed to be casting the short seller who was proved right, rather than the managements that had messed up, as the true villain of the piece. Nothing could have been further from the truth, but it was a complaint that received more of a hearing than it should have. Human nature is what it is. Millions of people — unconnected to the banking world — had lost their jobs or seen their living standards fall as a result of financiers’ failing. The spectacle of different financiers — to outsiders just more members of the same greedy tribe — making millions out of the disaster that had brought pain to so many was too much to bear. That the firm’s founding partner also became famous for spending a couple of hundred thousand dollars on an elegant Palladian-style chicken coop may not have helped.
Short sellers can make a living partly thanks to the opportunities repeatedly presented by investors’ gullibility and willful disbelief. Hope and greed spring eternal. Just this week, Markus Braun, the former CEO of Wirecard, a heavily shorted, once high-flying payments company headquartered in Germany, was arrested on suspicion of false accounting and manipulative business practices. The share price has collapsed. Over $2 billion in supposed cash balances (the money may never have existed) cannot be found.
Wirecard [has] acknowledged… that €1.9 billion ($2.1 billion) in cash included in financial statements — or roughly a quarter of its assets — probably never existed in the first place. The company withdrew its preliminary results for 2019, the first quarter of 2020 and its profit forecast for 2020.
The Financial Times has been on Wirecard’s case for some time:
Our colleagues at the FT — Dan McCrum, Paul Murphy, Olaf Storbeck and Stefania Palma — have been reporting on Wirecard’s accounting scandal for the past 18 months.
It all started with an FT investigation into Wirecard’s meteoric rise back in October 2018. Over the next year, Dan and the team delved into its suspected use of forged contracts, a preliminary report by a top law firm that there was evidence suggesting Wirecard employees engaged in a pattern of book-padding and made up partners that couldn’t be found, which gave us one of the best FT intros:
“Agostin Antonio was mystified. A retired seaman living quietly with his extended family of 12 in a suburb of the northern Philippine city of Cabanatuan, he had no idea why a company called ConePay International had used his address.”
In February 2019, the Wall Street Journal reported that:
Shares of Wirecard AG fell ell Friday 16% in Frankfurt after Singapore police searched the German payments company’s offices in the city-state as part of an investigation into potential accounting irregularities.
That same month, German authorities stepped in, but not, perhaps, in the manner that might have been expected.
The Irish Independent explained:
Germany’s financial regulator [BaFin] has taken the unprecedented step of temporarily banning short sales of Wirecard shares following reports of suspicious accounting practices, while prosecutors in Munich expanded their investigation to include a ‘Financial Times’ journalist.
Investors globally are immediately prohibited from taking new short positions or increasing existing ones through April 18, according to watchdog BaFin. That’s the first time it has banned short selling on a single stock and harks back to the financial crisis, when the regulator prohibited naked short sales on 11 financial firms….
The short-selling ban was coordinated with Munich prosecutors, who have launched a probe over potential market manipulation in Wirecard shares. In a statement on Monday, the prosecutor said it was investigating a complaint by an investor against an FT journalist.
The Wall Street Journal, two months later:
German payments company Wirecard received a $1 billion investment pledge from Japanese technology giant SoftBank Group Inc., a vote of confidence in a company struggling to get past accounting issues in its Asian arm and investor skepticism of its financial reporting and business model.
The stock soared 10 percent on the news.
Short selling is not easy. To start with, there is the cost of borrowing the stock. The bill for that goes up every day (and there may be other costs too). All this can be even more expensive than it already sounds. Competing to borrow stock in a company when the shorts are circling can be very pricey indeed.
Short-sellers were paying a 17.5% premium to borrow Wirecard shares as of June 16, one of the highest in Europe, data from industry tracker FIS’ Astec Analytics showed.
Adding to the risk, if there is a surge in a heavily shorted stock, there can be a “short squeeze” as panicked shorts scramble to cover the position, pushing the price of that stock even higher. Theoretically, a short seller can suffer unlimited losses.
In December 2019, Wirecard came (very) close to accusing the Financial Times of market manipulation:
We note that the publication of the article by the Financial Times coincides with the “Triple Witching Day” tomorrow, one of four expiry dates a year on instruments such as options, futures and of stocks.
That was then.
Short sellers, who borrow shares and sell them hoping to buy them back for less in the future, notched paper profits of $2.6 billion off Wirecard’s plunge, according to data-analytics firm S3 Partners. Bets by the eight funds with the biggest short exposure to Wirecard, including in options markets, delivered paper profits of $1 billion according to Breakout Point, a research service.
Short sellers do not always get it right, of course — far from it — and quite often they are right too soon, which, financially, is the same as being wrong.
George Soros… has lost $700m (£437m) betting against internet firms – the fledgling titans of the new industrial revolution.
The dotcom bubble finally burst the following year.
As John Maynard Keynes supposedly said, “The market can stay irrational longer than you can stay solvent.”
Short sellers do not always get it right, nor are they philanthropists. They (obviously) aim to make money. But to those who believe that financial markets work best when different investment views are, so to speak, left free to fight it out, short sellers play an invaluable role in helping investors form an accurate picture of what a stock should be worth.
The same, rather too often, cannot be said of either governments or the regulators who do their bidding.