MicroEcon-2010

Economics Research Assignment:

Short and Naked Short Selling & Their Impact on the Economy

The term “Short Sell” refers to a broker who borrows shares of a publicly traded

company from a third party, and hopes to sell back to the original owner at a lower price. An

example could a broker who borrows and immediately sells 100 shares of “Ryan Stewart Real

Estate Company” for $10 a share, equaling $1,000. The price per share falls to $7, so the broker

buys the original 100 shares back at a lower price of $700, and returns the original amount of

shares to the third party. Therefore the broker profited $300 while the stocks were losing value.

The term “Naked Short Sell” refers to the selling of shares, before you borrow them. If

there are many sellers of a particular share, then the price of the stock decreases. Brokers use

naked shorting to drive the price of a stock down. An example is someone trying to sell

someone’s house without their permission. The broker doesn't have the title to the home before

they have a buyer. Therefore the difference in short selling and naked short selling is that one has

the right to borrow a third parties stock and the other doesn't.

When any decently educated person wants to invest money into stocks they should look

at the current earnings of a company and their estimated future earnings. But what if a large

amount of brokers are collaborating to drive the stock price down by selling hefty quantities of

naked short sells? This will drive the price of the company’s stock down even though the

company might not have had any bad press such as a market scandal or firing of their CEO. In

my own opinion, I don’t believe this is fair to the stock holders. They have not been able to

forecast this coming or even had any notice until the damage has set in.

Here are some of the opposing arguments as to why short selling of stocks are beneficial:
“Although perhaps not readily apparent, short selling can advance important economic

goals. It can result in more liquidity, more capital formation, and more efficiently allocated

risk.”

(Troy A. Paredes, Commissioner, U.S. Securities and Exchange Commission)

“Banning short selling may help prices rise, but it also helps prices fall harder and

faster. What it does not do is stop overvalued markets falling - although it may delay the

inevitable, and make it happen more dramatically.”

(http://www.contracts-for-difference.com/Shorting-benefits.html)

Here is an argument as to why short selling of stocks is NOT beneficial:

“Here’s the thing. You figure that a company in which I own shares is overvalued by the market, and that share price is likely to fall. Accordingly, you decide to borrow shares to sell them short. Now, hold on a darn tootin’ minute there, pardner. Where are you going to borrow those shares? Somebody owns them… maybe they’re my shares. Why in the name of all that is good would I lend shares of a company to somebody whose only purpose is to see their value go down? I would not. It would never happen. Never!
So, how do you get your mitts on my shares? You go to my broker and make some arrangement to borrow my shares for this purpose. What I want to know is: How is my broker acting as my broker when s/he lends my shares, without my knowledge, to someone bent on creating a disservice to my interest. This is a structural flaw that seems to have been missed by so many, while too focused on how to dress up short selling for the ‘protection of the market’.
You can put a fancy dress on a greasy hog, and paint its face with lipstick and rouge… but no matter… it’s still a pig.

All of the discussion about share price manipulation, driving prices down, naked shorts,

painting the tape, etcetera, is moot. What must be addressed is at the very root of the issue. How

is my interest served when someone with an opposing interest is able to use my own assets as the

instrument of my demise?”

(Kevin Graham, http://www.grahamanalytics.com/Commentary/short_selling.html)

The above statement by Kevin Graham sums up everything I believe and sheds light on

the real problem. Why are the trusted brokers we use to invest our capitol into the stocks letting

other third parties borrow our stock for short selling purposes and in turn driving our stock prices

down? This should not be allowed unless the original stock holder allows or gets compensated

for doing so. Also, the broker responsible for my stocks should notify me before using my assets

in such a way. Not just written in FINE PRINT on the bottom of the agreement I had signed prior

to dealings with the company.

Lastly, if I were the CEO of a company I would not approve of short selling short or

naked short selling of my company’s shares. Although the argument of how short selling may

help the volatility of a share and benefit the stockholders, it still has a very large downside. Like

I said earlier, what if a large amount of investors were given false and misleading information

and in turn drove the stock price down by short selling the stock in large quantities hoping to

accrue profits? Then it leaves the company at the chokehold of the investors and might even lead

to the destruction of the company. Therefore as the CEO, I would be out of a job and at a

complete lose. The whole idea of selling something you don’t own just seems wrong to me. I

think short selling should be banned again, except for this time, INDEFINITELY.