There is one sure-fire feature of crises: lawyers and lobbyists from big companies descend on capital cities to try to enact their clients’ punch lists of protectionist fantasies. So it has gone with the recent imposition of short selling bans in South Korea, Italy, France, Greece, Spain and others. Not only are these bans solutions in search of problems, but worse, they harm markets.
Many of these big companies — let us call them corporate socialists, or CorpSocs — surely understand that the vast majority of selling during this market rout has been from investors with long positions. It is almost amusing to those of us in the short-seller community that anybody thinks we have enough capital to put real selling pressure on the market. During the recovery from the global financial crisis, numerous short sellers shut down and, right now, the two largest dedicated short selling firms in the world each manage much less than $2bn in assets. Contrast that to Fidelity Investments, which manages about $2.5tn of long-only assets.
Moreover, banning short selling reduces the ability of large long-biased investors to take risk, because it removes their ability to hedge. Say, for example, that a long-biased investor with a strong belief in Fiat Chrysler’s ability to manage through this crisis wanted to increase its exposure by shorting a basket of rival automakers. In this way, the investor would be able to neutralise much of the “beta”, or market movements, of its position in Fiat Chrysler. However, if you take away the ability of these long investors to hedge their long positions in times of extreme movement, such as these, the hypothetical investor above might sell part — or all — of its long position.
If further proof were needed that banning shorts is a dumb idea, it has been shown empirically that restrictions impose significant costs on markets. In 2012, three economists at the Federal Reserve Bank of New York published the results of their research into short selling bans imposed in 2008 and 2011. They concluded that not only did the bans have “little impact on stock prices” but that they “lowered market liquidity and increased trading costs”.
Since the last crisis, the CorpSocs got their tax breaks, talked up their stocks and made their management teams fabulously wealthy, with representation from law firms such as Wachtell, Lipton, Rosen & Katz, where the partners’ hourly rates exceed some people’s monthly earnings.
At the same time, many of them complained about shorts because, it seemed, we were the only ones who saw the folly of their short-termist and selfish ethos. Now their unbridled greed is blowing up and they want government help — while still trying to muzzle those whose job it is to expose what lies beneath.
Investors, however, benefit from the awareness of risks that short sellers provide. Short sellers have warned for years, for example, about the fragility created by companies issuing huge amounts of debt to fund buybacks and takeovers. Shorts have warned for years about China — and I have personally been warning about the pandemic risk China poses for more than a decade.
We see risks better than most policymakers and investors because it is our job to see risk. In contrast, the decadence of the post-crisis period saw some of the greatest gains flow to those who buried their heads in the sand and wilfully overlooked risk. This is the crowd that took its cue from Chuck Prince: “As long as the music is playing, you’ve got to get up and dance.”
Short selling is akin to the freedom of expression, and the ability to criticise the powerful that has formed the bedrock of our democracies for two centuries. In an era in which companies’ big legal budgets are often able to keep regulators at bay, short sellers are one of the few forces holding short-termist — or even lawbreaking — management teams accountable.
In December, my firm said NMC Health was a fraud; it has since emerged that the former FTSE 100 company has at least $4bn in concealed debts. Our exposures of other listed frauds have led to seven delistings by regulators over the years.
Those advocating for bans on short selling are driven either by wilful ignorance, or by a desire to further entrench corporate socialism as the overarching principle of our capitalist system. The more CorpSoc is allowed to drive capitalism, the more voters will turn against capitalism.
The writer is an activist short seller and the founder and chief investment officer of Muddy Waters Capital