Ok, I've done it. I told my children that I'm going to take them to McDonald's tomorrow evening. They see this promise as 100% good, as real as if they were actually holding the burger. The only difference from their point of view, is that if they were holding a physical burger now, by tomorrow evening it would be cold and bad to eat. The ones I have promised them are real burgers which are deliverable tomorrow evening, at the time we're going to want to eat them. So I've created two additional burgers owned by my children, in addition to all the physical burgers that currently exist, which are owned by either McDonald's, if they haven't been sold yet, or by customers if they have.
Does this mean that I've found an infinite supply of free burgers and should go into competition with McDonald's? No. Because I'm going to have to buy the burgers from McDonald's to supply to my children. They own two new paper burgers, but I'm short two burgers. So the net total world supply of burgers is unchanged.
Well you're still flawed if you scale your argument. What if you take your argument, and scaled it up. What if you promised each kid 1 trillion burgers. Will you have access to 1 trillion burgers tomorrow? What if they take their future 1 trillion burgers and sell half. What if you walk into McDonalds to claim the 1 trillion burgers. Does McDonalds have 1 trillion burgers? No.
So you're saying it's okay to promise burgers as long as it's an amount that actually exists and McDonald's can fulfil it. So what you're saying is that you shouldn't sell things you can't possibly fulfil? Hence the argument against this kind of trading.
Most financial institutions need some kind of basis for a promise - something that "secures" the contract e.g. like a loan secured by an asset.
A regulated entity might have capital requirements which would limit the no of burgers promised to money held. Another might be a contract with mcdonalds for N burgers, or a warehouse full of burgers - shorted stocks require the lender to actually sell a stock, and the shorter to actually sell it (and buy it back later) but there will need to be security/"deposit" on the returning of the stock - there exist a risk that the lender will not get their stock back, which is part of the reason for the premium.
Since you/I are not regulated financial institutions, not may would trust us to deliver 1 trillion burgers on paper; so the flaw exists in "What if they take their future 1 trillion burgers and sell half" - sell to whom? They'd have to find someone willing to buy. "What if you walk into McDonalds to claim the 1 trillion burgers" - the "paper burger" is an agreement between you and some third-party, not mcdonalds. You couldn't pre-order items from one shop, and go to another store with you invoice and demand they fulfil it - your contract is not some general/official currency, there is no obligation to accept it.
> So you're saying it's okay to promise burgers as long as it's an amount that actually exists and McDonald's can fulfil it.
It's a promise that you will supply N burgers, so the criteria for ok-ness is that you can supply N burgers, that McDs can provide that many is necessary-but-not-sufficient alongside:
- you can pay for N burgers
- you can transport N burgers (on time)
but when I say "ok", I mean from a "morality of making personal promises" perspective, not "financial promises/obligations made by a regulated financial institution" perspective. Individuals are not financial institutions, and financial institutions are regulated as such.
It doesn't inflate the supply, because the amount of people who own the share is equal to the number of actual shares, plus the number of people who are short the share. All the people who are short the share have to buy it back in the future. So the additional supply has exactly been matched by additional demand.
What you are saying is like saying that lending money to your friend creates inflation by expanding the money supply, because you still have $10 (that he's holding for you), plus he also has $10. In fact, since he knows he owes you $10, he's going to have to cut back on his spending at some point in the future, to pay you back. (Your mileage may vary with actual friends.)
Well, lending new money (i.e. an increase of lending over previous lending) does expand money supply and create inflation. If we look at the macroecomic aspects of money supply, most of current money supply is created through lending.
The key difference in your estimates of supply is that you include the future repayments of current lending, but ignore future lending. The general assumption in macroecomics is that we don't treat such lending as isolated one-off events, but as a sum of ongoing activity by many people, continuing forever at a stable level unless some event affects it.
Assuming that the principles governing lending don't change, the future repayments are balanced by payouts of new loans at that point of time, and the current payouts (if they are greater than current repayments of past debt, i.e. there's a net increase) are not balanced and thus increase the supply. If at some point the fundamentals change so that the lending decreases or stops then that event would decrease supply back to where it was.
I.e. if you often lend money to your friends so that usually someone or someone else owes you $10, then this lending is not a change and does not affect supply, but if you did not loan money and now you start lending, then that $10 is an increase in money supply.
> Well, lending new money (i.e. an increase of lending over previous lending) does expand money supply and create inflation.
You are talking about lending by banks, and/or the central bank, which is quite clearly money creation.
New lending of your money to your friend does not create additional money.
There's also a word game going on here. What you are describing is a situation where I lend money to my friend, and for the purpose of your analysis, you assume that I will always have lent out a similar amount of money forever starting now.
That's fine if that's what you want to analyse. But that isn't the situation I described.
> All the people who are short the share have to buy it back in the future.
Not if the company goes bankrupt though, right?
Seems like a potential strategy hedge funds can use (and maybe are using) is to short a company a ton and collect a lot of money from that. They can short more than the float, so even collecting more cash then the market cap of the company. This drives the price down, because there is more supply. The more they short, the more the price goes down. Then they just wait for the company to go bankrupt, which is more likely since the company's share price is in the dumpster.
Hilariously, the company going bankrupt can be even worse for shorts, since a bankrupt company will stop trading, and if it stops trading, the short position can't be closed.
> Seems like a potential strategy hedge funds can use (and maybe are using)
Anyhow, no, doesn't work. Even apart from getting burnt when the fraud is finally exposed and the company goes bust before your short position is closed or whatever (which is thankfully pretty unusual), stock borrow costs will eat you alive. Also, you can't short more than the float (short interest can be over 100%, but that's confusing net versus gross), you can't collect more cash than the market cap of the company, and you can't really bankrupt healthy companies by shorting the stock.
(The way short sellers (like Muddy Waters work is they find a company doing a bunch of fraud, they take out a large short position, then they publicise their research. If the market agrees with them, the uncovered fraud tanks the stock price, and they make a healthy profit. Sometimes the company ends up bankrupt and/or with their executives in prison, but the cause is the fraud, not the short selling. Short selling an otherwise healthy company into bankruptcy doesn't make a lot of sense in theory, and doesn't seem to happen in practice.)
> they take out a large short position, then they publicise their research. If the market agrees with them, the uncovered fraud tanks the stock price, and they make a healthy profit.
This is giving the market a lot of credit for being a rational and well-informed actor. The market is not full of people who calmly evaluate a short seller's argument and make a logical decision. It's full of people who lack the time, experience, and confidence to question the "financial expert" making dire predictions on the morning news and think "I should get out of this stock just to be safe".
Oh, I agree completely. Individual market participants make tons of mistakes, and absolutely won't be able to evaluate short (or long!) arguments correctly in many cases. That's actually one of the key elements supporting the efficient market hypothesis, and why so much ink is spent encouraging small investors to use index funds.
But it's a question of scale. The fact that any one investor may make mistakes doesn't mean that the market as a whole, in the medium or long term, also makes these sorts of mistakes.
"Some hedge fund guy released a report saying stock X is bad and the stock tanked 30% from small investors panicking before recovering when people realised it actually wasn't bad" is pretty silly, yes. And it's a bit rough on the small investors selling at a loss into the large investors who are able to correctly analyse the report, absolutely. But does any company actually go bankrupt in cases like this? The answer seems to be no; there's no evidence for it happening, and it's hard to see how it even could. Confused retail investors can lead to price volatility, but they don't make or break a new share offering.
Normally that's not really the case. There's a lot of academic and practical evidence that the most rational investors generally determine the prices of stocks, because even if there are a lot of irrational investors making random or systematic errors, a minority of rational investors all betting in the same direction ensure that prices are close to "correct", for some reasonable definition of correct.
In practice you just don't see examples of productive companies driven into insolvency by short sellers.
Yes but there's a counter to this and limit that is not there on the long side: Remember stocks are ownership in a company. If a load of "predatory shorts" jumped on and drove the market value of a company way below of where it should be, I could jump in with sufficient money and make a tender offer. Then I'd own a real company with real assets for a fraction of the cost and take it private. And the shorts would have to cover their shares.
There's no such reality check with things going up on the long side as we see from Gamestop. Someone can't step in and cash out on the company at a ridiculously high price compared to fundamentals. It is only driven by the market. In general short sellers are vilified more than warranted. If you are long on a good company you should applaud them because after all, they now have to buy back at some point. People view it as if you are some villain going against what is right (shares just going up and everyone gets rich). Stocks that go down with high short interest are almost always going down because they are bad companies, not due to short sales.
This is a perfect compendium of the flimflam put out by those who object to short selling.
'a physical share' No. There's no such thing. Even a physical share certificate is not a physical share. It's a physical piece of paper which documents a nebulous thing - the set of rights you have, and terms between you, the company, its management and other shareholders.
'slippage and volatility'. No. You bought the share at the price you were filled on. No slippage. One share gets lent out, one share gets returned. You are not affected by volatility in any way, because the share your get back is exactly the same as the one you lent, and the price change would have affected you anyway.
'A substantial loss' When a share your broker lent out fails to deliver (which you would never know about), the broker doesn't write to you and say 'oops, your share didn't make it back, your loss'. First of all they didn't write your name on the same before they lent it. They have a bunch of shares which they lend out. Secondly, someone will have to produce either the share or the exact amount of money required to buy an identical share at some point. Thirdly, even if they didn't, the broker would make good any loss, whether inadvertent or due to some mysterious malfeasance. That's literally the reason your broker holds capital and is regulated.
A share is not like an apple. You buy a share with the clear intention of selling it to someone else one day. It's a speculative activity par excellence. People who buy apples in order to trade them are generally quite comfortable with the fact that 'their apples' are in reality just a binding contract on someone else to produce those apples when asked. In the same way, the bank does not have 'your money' in a pot somewhere. They just promise to produce it under certain conditions, and there are regulations making sure they keep this promise. I get that some people think this in itself is suspect, but if so, you are opposed to most aspects of modern finance, why pick on short sales?
If you buy a share, your order to buy one will most definitely be met. They can't lend out something that hasn't been bought. You might be confusing short selling with another bugbear, order internalisation and PFOF.
> If instead my money is “borrowed” without my concent for some nefarious activity
What activity? Who is borrowing your money?
> whose money is being stolen
Your money was used to buy the share.
Want to sell the share? It's there. Want to vote the share? It's there provided that you actually paid for it with cash. Oh, you bought the share on margin? Well, the same as a car which you borrowed money to buy, the share does not fully belong to you in those circs. So depending on the rules, you might not be able to vote it.
> That these shares do not exist, isn't some slip-up.
The share definitely exists. Allowing retail investors to bet on shares going up and down without any actual shares trading hands is illegal, since the 1930s.
'without your knowledge'. Everyone knows about this. That's literally why we're taking about it.
>loan it out in order to sell it in the hopes of earning money if its value drops
The broker doesn't earn money if its value drops. They lend out a share, they get back an identical share.
>Clearly you'd want to know if your property is being loanded out, because it means that you're incurring risk
No more risk than the general risk that your broker (or bank) will fail, that the regulator got it wrong and they don't have enough money to pay everyone back, and that the govt won't step in if this happens.
And you do know.
And you are allowed to ask them not to do it. If you paid cash for the share.
Oh, you bought the share on margin? So the broker stole someone else's money from their pot at the bank where they thought it would be taken care of, lent it to you for nefarious activity, and you spent their money on a share you couldn't afford yourself, with the express intent of making the price go up? Shouldn't that be illegal? No, margin investing is conceptually very similar to short selling and is also an accepted part of modern finance. The broker lends you money, you buy a share, you hope it goes up, when you sell the share you pay back the money. The broker lends a short seller a share, they sell it, hold onto the money, hope it goes down, when they buy back the share they give it back to the broker.
There are tons of problems with finance and financialization in modern society. This isn't one of them.
Gathering more data on this object is essentially impossible right now. There's a telescope coming online soon (LSST) that should detect many more objects like this, though.
I mean, you're just reciting the arguments that the science establishment generally recites.
We have spent tons of money on particle accelerators to no clear benefit, either to science or to society. If a similar amount of money had gone to SETI, many of the above objections would have been addressed and resolved, with the advantage that science is being done which the average person paying for it is likely to a) understand what is being asked and b) be interested in the answer.
I did pull my arguments out of the "Big Astronomy: Let's Keep Down The Little Guys" playbook. Come off it. The "science establishment" repeats things because there's compelling evidence and scientific rigor supporting those things. It's not some "Big Science" conspiracy.
Particle accelerators have exploratory experiments like hunting the Higgs boson with LHC but they run lots of other experiments as well. There's also lots of particle accelerators (of varying capability) around so if you devise an experiment needing one you likely have several options unless you literally need the LHC.
With large telescopes there's far fewer available and the sky is pretty big. Radio SETI is a long shot search and optical SETI even more so. It's not that they lack merit but getting funding for telescope time is a lot harder when the chance of any positive finding is very remote. A lot of SETI funding actually piggybacks on other research using the same telescopes.
The chances of SETI finding positive results isn't necessarily from a lack of things to find but from physical limitations. Our best radio telescopes could only detect Earth's more powerful radio emissions from a few light years away. Broadcasts like TV and radio wouldn't be detectable outside the solar system. The inverse square law is a stone cold bitch for interstellar communication. SETI's best hope of finding signals are ones intentional ones.
Even with billions of dollars SETI would have similar chances of detecting an ETI as without. It's a needle in a haystack search with warehouse sized haystacks. More money doesn't necessarily get it done much faster or better. There's a limited number of sites for large radio telescopes and they have limited fields of view and stars are only in that FOV for a limited time. More money might let you search the warehouse sized haystack a few times faster but it's still a vast search space.
If person A wants to get paid to do something and person B wants to do the same thing to a similar quality for free as a leisure activity, isn't it sort of expected that it will become hard for person A to make a living? Doesn't it make sense that to make a living they will have to either produce something far better than the amateur, or do the parts that amateurs don't want to do, or differentiate themselves in some other way?
It seems to me that it would be an odd society which didn't even allow people to ask questions about the relative merits of person A and person B's work, in case they found out something which would be disruptive to person A's business model.
You are missing something - these aren't naked shorts. The fact that more than the whole float is out on loan does not imply that naked shorting is going on.
Please explain. I thought this was the whole purpose behind hedging, was to avoid the short squeeze. Are people reneging on the purchase agreements or overpromising? How can we know these aren't naked shorts and if so, why are they still facing the short squeeze?
See footnote 3. "This does not necessarily mean a lot of people are doing evil illegal nefarious naked shorting! Really, I promise! There is no special limit on shorting at 100% of shares outstanding! Here is an explanation of how options market makers (discussed below) are allowed to short without a locate, but I want to offer an even simpler explanation. There are 100 shares. A owns 90 of them, B owns 10. A lends her 90 shares to C, who shorts them all to D. Now A owns 90 shares, B owns 10 and D owns 90—there are 100 shares outstanding, but190 shares show up on ownership lists. (The accounts balance because C owes 90 shares to A, giving C, in a sense, negative 90 shares.) Short interest is 90 shares out of 100 outstanding. Now D lends her 90 shares to E, who shorts them all to F. Now A owns 90, B 10, D 90 and F 90, for a total of 280 shares. Short interest is 180 shares out of 100 outstanding. No problem! No big deal! You can just keep re-borrowing the shares. F can lend them to G! It's fine."
Right, seems like a similar problem to banks and leverage. People can short more in aggregate than exists the same way the money multiplier exists for banks. But there are bank runs and it's built on trust, so that's risky too and we make people hold on to a certain amount to cover what they lend.
I guess I'd just prefer they use call options to cover the shorts instead of borrowing. No leverage or multiplier effect there. Gets too high, just execute the call. Am I also missing something there?
So, first of all, the net shares outstanding are still 100. All the extra, whatever, 200 shorts are balanced out by 200 extra longs, and that creates obligations between them, which must be managed as usual (collateral, margin calls, risk limits, ...)
To short a share, you must borrow and sell it.
If you buy a call, you're long. You could write a call and then you'd have short exposure, indeed, but on the wrong side - you lose on the way up, while you want to win on the way down. So, you could buy a put - that makes you short, winning on the way down. However, now the entity that wrote the put is long, and will generally cover their exposure by - shorting. No magic bullet there.
You can have a short squeeze without naked shorting. Shorts who aren't naked have borrowed the stock from someone. If that person asks for it back, they have to go out and buy it in order to return it.
At least in theory, if retail investors buy up the stock, some of the institutional investors who own it, and who have lent it out, will sell it to them. This could mean that they recall lent stock. As this happens, shorts might have to compete to buy the stock. Equally, as the price gets higher, shorts might have to cut their losses, which also means buying back the stock. If the people buying it now don't sell it and don't lend it they will withdraw a lot of the supply.
Since you're nice and explaining things...what happens if a naked short gets called in but literally no one will sell any stock for any amount of money, so the shorter can't fulfill their obligation?
Obviously not going to happen with GME or anywhere realistically, but I'm just curious how that would be handled.
Something called a Failure To Deliver. Basically you have to pay extra to keep the stock one more day or whatever, and you have to deliver it the next day, or next settlement period.
The fee could be quite punitive, or fairly trivial depending on the market. In some markets failure to deliver would be a very big deal and multiple could lead to some sort of disciplinary action. In other markets they might be commonplace for whatever technical reason, and everyone expects that they will happen, just tries to avoid them because of the fee.
There are various theories that in certain markets everyone fails to deliver all the time and it means that there isn't enough of whatever to meet all the obligations. I can't really comment on how much they make sense.
So it seems the issue is that people have borrowing agreements that can be recalled early (seems like it functions like a margin call in a way). Call it half-naked shorting, I guess. Still seems risky. I feel like they could've just bought call options and called it a day instead. Maybe that's too naive or call options are hard to find/pricey for Gamestop?
That still doesn't explain how you know folks aren't naked shorting. Maybe you can read the trades?
I don't know they aren't, but it's illegal. Large hedge funds are unlikely to be breaking the law, and I haven't seen any evidence that they are which wasn't based on a misunderstanding of the free float numbers.
Stock borrowing is very very commonly done and renewed per-day, in the vast majority of situations this works fine.
I appreciate the explanations, thanks. I don't have the trading context. Seems like tail risk or Black Swan events yet again. I hope they made enough money on these shorts that it wasn't "picking up pennies in front of steamrollers". If not, then I wish there would be better rules to prevent the short squeeze, like requiring calls instead of stock borrowing (maybe this is too expensive). When the liability is theoretically infinite, it just seems really risky to count on the hope that you can keep borrowing the stock (which works great the vast majority of the time but every now and then you lose billions).
> These points doubtless make me appear to be a complacent shill for the financial industry, talking down to the rubes
For context, in 2008 John Authers was a (very senior) Financial Times reporter on Wall Street. He became aware that there were queues of financial workers outside retail branches of banks in South Manhattan. These people had cash in various US banks, more than the insured deposit limit, and were withdrawing it and/or shifting it between accounts to protect themselves against the bankruptcy of major banks. They has a better idea than the newspaper-reading public of what was about to go down.
John decided that this wasn't worthy of being covered in the FT. He did however queue up himself to move his own money so it was protected.
You can judge for yourself whether that makes him likely to be a complacent shill for the financial industry, talking down to the rubes.
"Was this the right call? I think so. All our competitors also shunned any photos of Manhattan bank branches. The right to free speech does not give us right to shout fire in a crowded cinema; there was the risk of a fire, and we might have lit the spark by shouting about it."
Enraging. You're allowed to shout fire in a crowded theater if there is, you know, a fire. Tapping all the people in the box seats on the shoulder to give them a heads up about the fire so they can get to the exit before everyone stampedes for it is sociopathic, not social-minded.
I guess it's to his credit that he admitted to this, in the same sense that I'd credit a murderer confessing his crime and bringing the police to the body.
While I mostly agree, it is a touch more subtle than this metaphor.
Shouting fire in a crowded theatre doesn't typically cause the fire to get worse.
A major newspaper breaking news of an impending bank run, does have the likelihood of actually being the thing that triggers the bank run, or maybe making it much worse.
Just because I love torturing an analogy until I can get it to confess all its sins...
It's most like a theater having a squad of firefighters on hand, who most people ignore, as the theater has told them that the usher will let them know if a fire gets out of hand. One day the usher sees all the firefighters freaking out and quietly running for the exit, and his response is to flee for the exit himself and leave everyone remaining to fend for themselves.
I do get the moral complexities here, but the takeaway for us plebs in the audience is to not trust the usher to look out for our lives.
It's more like no one actually saw fire, but the back half of the theater snuck out and ran away because there were rumors of a fire. Authers saw this happening and had a chance to tell the people in the front of the theater that the whole back half had thought there was a fire and ran away, but he decided to just slink out the back and leave the front half to get burned.
I'd be ashamed to call myself a journalist if that was how I behaved.
What if the act of telling people in the front half caused a stampede, which trampled five people to death, knocked a candle over, and burned the whole theatre down?
The thing about bank runs is that if everyone, everywhere thinks there's a bank run happening, this will actually cause the financial system to collapse. It's a self-fulfilling prophecy.
But if most people don't think a bank run is happening, then the system can weather a few bad banks popping.
There was an actual shortage, though, because people's needs changed. Nobody wanted to go to the grocery twice a week when most of the variables of the pandemic were unknowns. Nobody needed commercial toilet paper, but everyone started needing residential toilet paper. Some supply chains for staples were disrupted. (Meatpackers in NYC all getting COVID...)
Many supply chains are still disrupted, relative to changes in demand, just try buying a GPU right now.
It does however feel weird in the same way that "odd female something", "odd muslim something", "odd socialist something", "odd atheist something".
Leaving out details that are not relevant is IMO smart because it helps the reader to avoid prematurely making up their mind because of irrelevant details.
So my take is tptacek should be allowed to write it and we should be allowed to point it out.
And one more thing: my respect for tptacek has been growing even if we clash from time to time in various settings.
I don't want to dismiss what she experienced and how upsetting it must have been, but "she received death threats" covers a lot of ground.
Apparently lots of people make internet death threats all the time. Every single case like this mentions death threats. I don't think these death threats are in general credible. Clearly at least some of them are made by people who just join in with and escalate online arguments for amusement. I assume at least some of them are made by people hoping to 'discredit the other side'.
Does this mean that I've found an infinite supply of free burgers and should go into competition with McDonald's? No. Because I'm going to have to buy the burgers from McDonald's to supply to my children. They own two new paper burgers, but I'm short two burgers. So the net total world supply of burgers is unchanged.