Posts tagged ‘Big Short’

The Virtues of Short-Selling

Is there anything that rankles populists who are "anti-speculator" more than the ability to short stocks?  From time to time countries that are upset about falling markets will ban short-selling.  But I have defended stock (and other asset shorting) as a critical market mechanism that helps to limit damaging bubbles.  I wrote waaaaaay back in 2008, after the US temporarily banned short selling of certain assets:

At the start of the bubble, a particular asset (be it an equity or a commodity like oil) is owned by a mix of people who have different expectations about future price movements.  For whatever reasons, in a bubble, a subset of the market develops rapidly rising expectations about the value of the asset.  They start buying the asset, and the price starts rising.  As the price rises, and these bulls buy in, folks who owned the asset previously and are less bullish about the future will sell to the new buyers.  The very fact of the rising price of the asset from this buying reinforces the bulls' feeling that the sky is the limit for prices, and bulls buy in even more.

Let's fast forward to a point where the price has risen to some stratospheric levels vs. the previous pricing as well as historical norms or ratios.  The ownership base for the asset is now disproportionately
made up of those sky-is-the-limit bulls, while everyone who thought these guys were overly optimistic and a bit wonky have sold out. 99.9% of the world now thinks the asset is grossly overvalued.  But how does it come to earth?  After all, the only way the price can drop is if some owners sell, and all the owners are super-bulls who are unlikely to do so.  As a result, the bubble might continue and grow long after most of the world has seen the insanity of it.

Thus, we have short-selling.  Short-selling allows the other 99.9% who are not owners to sell part of the asset anyway, casting their financial vote [on] the value of the company.  Short-selling shortens bubbles, hastens the reckoning, and in the process generally reduces the wreckage on the back end.

I am remembering this old post because Arnold Kling links an interesting bit on economists discussing the Big Short, who among a number of interesting things say this:

Shorting the market in the way they did is very risky, and one has to be very confident, perhaps overconfident, in one’s forecast to take such risks. As a consequence, many people who were pessimistic about the housing market simply stayed on the sidelines—which in turn meant that for a while, valuations in the market primarily reflected the beliefs of optimists.

The timing issue is key.  I have been right probably in 4 of out the 5 major market shorting opportunities I have identified in the last 10 years, but have been on average 2 years early with all of them, meaning I lost money on most of them, or made money after enduring some really big paper losses for a while.

Outrageous -- Hedge Funds Using Obama Administration to Gut Their Short-Selling Targets

Living in Phoenix I know a number of people who work for Apollo (University of Phoenix).  They have obviously been appalled by the Obama war on for-profit colleges and the egregiously-flawed report that came out last year.  Several have told me they have complained for a while that certain hedge funds were pushing this initiative in order to make money off of short positions on their stock.  I thought this was a bit paranoid, but now the accusation is coming from third parties, even those on the Left:

A proposed regulation from the Education Department threatens to devastate for-profit career or trade schools, but one thing is even more controversial than the regulation -- how it was crafted.

Education Department officials were encouraged and advised about the content of the regulation by a man who stood to make millions if it were issued.

"Wall Street investors were manipulating the regulatory process and Department of Education officials were letting them," charged Melanie Sloan of a liberal-leaning ethics watchdog called Citizens For Responsibility and Ethics in Washington....

Among others, Sloan is referring to Steven Eisman, a hedge fund manager and a figure in the book "The Big Short," who testified in the Senate against for-profit career or trade schools, attacking them as "fundamentally unsound."

At the same time, he was betting that the stocks of those companies would fall, a practice known as short selling. "Making sure that they were going to be defamed and that their value was going to be depressed," said Harry Alford, head of the National Black Chamber of Commerce, who worries about the schools because they serve many minority students.

Simultaneously, through emails and conference calls, Eisman was advising Education Department officials -- and one White House adviser -- in detail on how best to write the new regulation, which he estimated would reduce the schools' earnings by as much as 75 percent.

The proposed regulation from the administration is aimed at what are known as career or vocational schools. The rule would cut federal aid to programs where student debt levels are deemed to be too high and where students are struggling to repay their loans.

In other news, everyone seems A-OK with kids in not-for-profit universities running up $200,000 debts to get such lucrative, workplace-ready degrees as women's studies, comp. lit. and poetry.