Perry Glasser

A Case of the Shorts

In Business, Economics, Personal Finance, Wall Street on September 24, 2008 at 11:50 am

 

Short selling is much in the news these days, but a lot of non-Wizards find the idea of selling something they do not own hard to grasp.

Actually, it is easy, and, before the Wizards changed the rules, made great sense. 

The Cat Food Story

Suppose you live in the middle of a street and both of your neighbors, East and West, own cats. The East family asks you to feed their cat, Iolanthe, while they are out of town for a week. Being a good neighbor, you accept. They leave you with seven cans of cat food.

A week after they are gone, the Easts call your from O’Hare Airport with an urgent request. Their return home is being delayed (This is O’Hare—if this is January, they will be lucky to get out of Chicago at all). They’ll need you to feed Iolanthe an eighth day, and they ask you to pick up some cat food, for which they will happily reimburse you.

Pressed for time, as you leave for work, you stop at the Wests and ask to buy a can of cat food from them. They happily oblige. The can is plainly marked $1.29; all they ask is that you replace the can soon.

You feed Iolanthe, leave the price-marked empty can at the East home to show the cat food price, dash off to work, and you stop at the pet store on the way home. Lo! Cat food is on sale for $.79!

You buy one can. You return it to the Wests.

The next day, the Easts return home. They write you a check for $1.29—the price of the empty can of food.

You just made $.50, and you did it by selling a borrowed asset that you sold before you purchased a replacement asset at a lower market price.

  • You borrowed an asset from the Wests.
  • You sold the assets to the Easts for $1.29.
  • You went to the market to purchase the asset for $.79.
  • You restored the assets to the Wests.

Look! You just made money by selling before you bought anything!

Hedging

Selling short is a time-honored financial strategy that the modern Wizards have made dangerous by ever so slightly changing the rules while they did their work behind the curtain. The purpose of short-selling is to hedge.

Hedging is a fancy word that translates to: KEEP THY FINANCIAL ASS COVERED!!

Suppose you were sitting on a pile of assets you believed over the short term were going to diminish in value. Rather than sell and re-purchase later, for a fraction of the cost of a sale and repurchase, you could short part or all of your position and lessen the pain of the loss. When you borrow your own shares to sell, while maintaining ownership to collect benefits of ownership such as voting rights or dividends, the strategy is called “short against the box.”

Short against the box is very, very conservative, a tactic not designed to make bundles of cash, but to cut losses…to hedge.

Enter the Wizards.

Naked Shorts

 

Despite the name, which sounds like a product from Victoria’s Secret, naked shorts are a bit of wizardry designed to make what was conservative the play of a buccaneer.

These are your pros at work, the financial managers in $1,000 suits who humbly accept responsibility for our money,and once they get supervision of a trillion here and a trillion there, management of our financial system

Unlike cat food, Wizards are aware that most transactions do not call for the transfer of any underlying  real asset, but only a bookkeeping entry, with the blessing of government supervisory agencies, the Wizards created the naked short.

In the cat story, they have cut out the Wests. No cat food, in fact.  No need to borrow cans anymore, just make the ledger entry. Conceivably, we could put in more short-selling orders than there are cans of cat food in all the world…

Now substitute for the phrase “cans of cat food” the phrase, “shares of financial stocks” and you’ll see why the US Financial system is not worth a bucket of kitty litter.

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  1. […] July, 2007, the SEC abolished the Uptick Rule on short selling, thus orchestrating a new era of stock market manipulation that will out-do the world-wide […]

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