Sounds pretty sexy, eh? Anything with "naked" and "shorts" in the title ought to involve Spring Break co-eds, but not today. This is an update to the financial story I blasted out on Facebook a few weeks ago. The story came from Rolling Stone and basically describes this basic scenario around short selling.
First a very basic explanation of short selling on the stock market which is 100% legal and a good thing to do. Say you have a feeling that stocks in BobCorp are going to go down. They've been flat for a while and the whole Bob-sector is down and you think BobCorp is likely to drop soon. So you come to me (a big BobCorp stock owner with 10,000 shares) and you ask to borrow them for a few days and I agree. You take the shares I gave you and promise to pay me back or return all my shares in 3 days. The current share price is $100 and so the total value is $1,000,000. You immediately sell all my shares for $1 mil. The next day, the fallout you expected happens and BobCorp shares fall to $50 a share. You then immediately buy back 10,000 shares at a cost of $500,000. You then give me back my 10,000 shares and pocket the difference--a cool half mil for only 2-3 days work. Again this is all legal and it work because really there are a few fees in there for me and the broker.
Now in this example I was the stock owner of real shares. I really gave you 10,000 shares to sell and you really bought and sold 10,000 shares. All good. But this not what is happening *today* on the US stock market. Today if you wanted to short sell a stock you would only have to call up your broker and tell them you wanted to short sell 10,000 shares of BobCorp. They may not have 10,000 shares to give you, but they'll act like they do and they'll sell off 10,000 shares for you (they get a % fee on all transactions remember). But in reality lets say they only owned 8,000 shares to lend. But in the US you can still pretend you have 10,000 shares and so 2,000 shares are effectively "created" from nothing and sold to the market. Some buyer got 2,000 bogus shares in the deal. Later you buy back the shares from the market and give them back to the broker. Maybe they are "real" maybe not... it doesn't seem to matter, the extra 2,000 shares stay on the market. This is Naked Short Selling. Now the broker knows those 2,000 shares are not real and they are keeping track of them. They will pay dividends (if any) on them because they make so much money on the fees that it is still profitable for them to float these shares.
The real problem here is that there is not even a rational limit on how nuts you can go with overselling shares. Most people realize that if you flood any market with goods the price goes down. The same is intensely true of the stock market. So here you have a system were you can totally artificially create more shares and then flood them on the market to drop the price--which totally *works* for you because you're more and more money the farther the price tanks. In fact, throw in a couple of nasty rumors about impending lawsuits or the CEO sleeping with underage hookers and you get a real old fashioned hachet job on the stock price. You make a mint. The company you just abused? Well it will might recover or maybe it just files for bankruptcy. Who cares? You made millions. Other investors in that business will take the loss.
This is all legal in the US. The current stock trade system doesn't verify that a broker really has the shares they lend and since the brokers are paying the fees and handling the transactions--no one complains. Folks who have complained (for years) have been ignored. It obviously makes too much money to be stopped. Incidentally... some of the folks most likely to used this trick in the biggest ways are now financial advisors to the President and hold seats on the SEC...
Interestingly enough... this doesn't work in New Zealand. Trades have to settle in 3 days. That means you have to really have the shares in 3 days or the broker is busted. I can't speak for other markets around the world, but I suspect most of them have a way to prevent this. This corruption is obvious to the rest of the world. But I don't see too much outrage about it in the US press... I don't think it was even reported by CNN... hmmm... wonder why?
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