During the past three weeks, shorting of stocks and indices has increased tenfold to twentyfold. Shorting is selling a stock or index not owned, but presumably “borrowed” from an account of a person or entity. In this way, presumably, the number of shares sold “short” cannot exceed the number of shares available for public trading. Shorting is selling on credit. A major “cost” for a short is to pay any dividend that would have been received from the stock to the actual owner of the stock. If this seems contorted, it is because the stock market has turned gambling casino.
Imagine a rule that an entity, such as a hedge fund, could sell what it does not own applied to your house. Imagine for whatever reason, local housing prices have been static. Imagine the entity shorts other houses in your neighborhood. Consequently, houses in your area take a price dive. The entity makes money just by selling into a static market. Now imagine that folks in your neighborhood have some real concerns about the sewer system or the road resurfacing or some other issue related to future taxes. The fall in prices erodes confidence. Neighborhood folks become demoralized and some actually sell to get out. The whole process feeds on itself in an accelerating downward cycle. The entity that shorted makes a bundle while laying waste to the neighborhood and people’s fortunes.
This is precisely what is going on in the stock market. Massive shorting is screwing innumerable pensions, insurance companies, trusts, NGOs, IRAs, and little guys everywhere. This massive shorting is funded by deep-pocket wealth and credit guided by computer algorithms and statistical models.
Fundamentals, the future success or health of a company, or its role in the larger economy play little role in the shorting. Computer algos are blind to the specifics of an individual company, its function, management, location, products or services that it provides to the general economy. Small company stocks, those dependent upon high cash flow, and those likely to be hit by low demand during the crisis are the first choice for shorting. Since future performance of a specific company is fraught with uncertainty, computer driven shorting is ruled by statistical models that aggregate companies into categories. Every member of the category goes into the toilet.
Unregulated massive shorting is responsible for the most dramatic fall in the stock market over the shortest time span since the Great Depression of 1929. The present value of the companies and indices puts at risk the continued existence of a significant fraction of small and medium size businesses and entire categories of production essential for national well-being. The failure of businesses paves the way for the end of predictable work and occupation. The fall intensifies fear and concern about the stability of the financial system itself and raises the specter of a new Depression.
Massive shorting is equivalent to plundering. In the free market this practice has dubious benefits to the society or economy. While Rome burned, Nero fiddled. The Securities and Exchange Commission has been asleep at the wheel and has failed its moral or regulatory obligations. The SEC needs to act immediately under its emergency provisions to disallow shorting and reconsider regulations that apply to its future management.