Equity short sellers come in two basic varieties: First, “naked shorts” who borrow shares from another account to sell the shares to be repaid later, and second, “sellers against the box” who possess the shares they sell short. Sellers against the box are hedging a position, holding the shares that are sold. The bulk of declines in recent market action was due to naked shorts who have borrowed shares. This practice dramatically increased the rate and decline of equity values.
Naked shorts have “no skin in the game” in the sense that are not owners but only sellers. Since they have no interest in a company, other than selling it, naked shorts, by definition, are opportunistic. Their interest is simply profit from market decline or turbulence. When naked shorting is practiced on a massive scale, the impact on equities valuation is massive. Responsible fiduciaries, funds, trusts, retirees and the general public are its victims.
As the Federal Reserve, the Treasury, Congress, and White House endeavor to restore a modicum of fiscal sanity to markets and the economy at a cost in the trillions of dollars, a return of the opportunistic gains from naked shorting would aid fiscal restoration. Two immediate alternatives are available: First, at the Federal level, profits from naked shorting can be taxed at a higher rate. This would be welcome addition to a Federal budget that is likely to have a deficit larger than any in its history, including World War II. Second, equity exchanges can require naked shorts to buy back shares. Exchanges can mandate that naked short positions be closed. This requirement would cause equity prices to accord with values based upon the judgment of actual holders of equities. To discourage future catastrophic declines in equity values as occurred during March, naked shorting ought be disallowed for all future equity transactions. This will eliminate much of the “casino” quality to equity investment to be mourned by a few, but welcomed by the majority.
This would mean that to sell or short a stock, one must first own it. What a revolutionary idea! I conjecture that the entities likely to take a hit to their profiteering would be offshore funds (located in the Bahamas, Cayman Islands, Panama, etc.) who operate for opaque interests, long-short hedge funds, selected insiders, and the usual suspects. The Exchange requirement to “close out” borrowed short positions would trim their profits, but the profits were ill-gotten –and, in fact, depending upon the time frame required for “buy back”, the entities involved likely would still make gains. Hopefully, these gains would be taxed at a special rate to be determined by Congress.