Saturday, October 13, 2012
Almost everyone is (or has been) a short-seller
People often have difficulties wrapping their head around the idea of selling a stock short. It seems odd. Once people understand how it works, they also tend to perceive short-selling as immoral. They also assume that only a few malcontents engage in that sort of transaction.
But everyone either has been, is, or will be a short-seller.
When you short a stock, you're basically borrowing a stock and immediately selling it in the market. When the lender of the stock demands the stock back, as the short seller you've got to buy the stock back in the open market and deliver it to the lender.
Now consider someone who borrows from the bank. You borrow a deposit and immediately sell it in the market. When the bank demands the deposit back, as the borrower you have to buy the deposit back in the open market and deliver it to the bank.
These two transactions are the same transaction. Borrow an asset, sell it, and when the lender requires delivery, buy it back and deliver it to the lender. Anyone who borrows from a bank is a short-seller.
Part of the ethical argument against short selling has been that short sellers are hoping for lower stock prices. The reason short sellers want a stock's price to fall is that it allows them to buy the stock back at a cheaper price and deliver it to the lender of the stock, thereby earning a good profit. Wishing for a lower stock price is presumably the unethical part. It's a form of schadenfreude.
But anyone who borrows from a bank wishes for the very much the same thing! When the bank calls in your loan, you really hope that those deposits have fallen in value. That way you earn a profit. You earn a profit because you don't have to sell as many real resources to repurchase the deposits as you initially bought with the first sale of deposits. There's also schadenfreude involved here. Wouldn't you prefer if the bank had gone belly-up? Or that your nation's central bank had gone hyper-inflationary? Either way, buying back the deposits will be a cinch.
So if short selling is only done by vultures, so is borrowing. If the former should be banned, so should the latter.