Why Short Selling is Bullshit (Part 1)

This is a series I am writing up about why I believe ALL short selling, not just naked short selling, should be banned.  

Part 1: Short sellers target financially vulnerable companies, NOT fraudulent companies  

Part 2 Part 2.5: Why capital intensive technology companies are prime targets of shorting  

Part 3: Shitadel and Friends are Shorting Innovative EV Companies for Liquidity to Fight GME  

Part 4: How Superstonk is putting a stop to the game (see what I did there?)

   

Okay, let’s get into it. I’ve been seeing a lot of posts, both from respected users and mods, distinguishing naked short selling and regular short selling, stating that normal short selling has a role in the markets to detect fraud. While I respect the users and the sentiment, the purpose of this series is to discuss whether or not that statement is true, and to state and defend my thesis: All short selling is wrong and should be banned (both naked and otherwise!).

   

First, let’s go over how a typical short sale is supposed to work. In regular short selling, a market participant borrows a stock from a stock owner, and sells it on the open market. The market participant then pays a daily interest fee on the stock that he borrowed, which he pays to the owner of the original stock. Later, when the price of the underlying stock falls, the market participant buys back the stock at a lower price, and returns the shares to the original owner of the stock. The market participant pockets the difference, as they have “identified” an overvalued stock or a price dislocation and profited from the difference. The shortseller can hit a “jackpot”, where the underlying company goes bankrupt, rendering the stock worthless. In this case, the shortseller no longer needs to go back into the market to purchase the underlying stock, and they can pocket whatever they originally sold the stock for, minus the interest fees. Also, the money earned is tax free, for some reason.

   

In naked short selling, the market participant does not locate the stock to borrow, and simply sells as many shares as they want into the market. This leads to a float of counterfeit shares, which drop the price of the underlying asset, as the supply of stock has massively outstripped supply. When the stock has dropped low enough, the market participant can then buy back their shares, and profit from the difference. The naked shortseller can hit a “jackpot”, where the underlying company goes bankrupt, rendering the stock worthless. In this case, the shortseller no longer needs to go back into the market to purchase the underlying stock, and they can pocket whatever they originally sold the stock for, minus the interest fees. Also, the money earned is tax free, for some reason.

   

If you noticed from the previous two paragraphs, there actually isn’t too much difference between regular short selling and naked short selling. So wait….whats the purpose of short selling in the first place? Let’s hear papa musk tell it as it is: https://www.youtube.com/watch?v=gK3Bvmh2XeQ

   

Next, I want to try and dispel the myth that short selling has a useful role in detecting fraud in the markets. First, let’s go over the obvious: we now know that fraud is rampant throughout wallstreet. Even before superstonk, we knew that fraud was rampant throughout wallstreet, but we didn’t understand how fraud was being perpetuated. Second, a large number of fraudulent companies are not even listed on stock exchanges, so they cannot even be shorted (Hello Citadel!). If shortselling was useful in detecting and punishing fraud, don’t you think wallstreet would be less fraudulent, and more honest? Hmm….

   

There is only one true purpose of short selling: to profit from the value of a company decreasing. There is no other purpose to short selling. The greatest profit to be extracted from short selling is to identify companies which are financially vulnerable, and to profit from their vulnerability. “Short selling has a valid function to detect fraud!” you might say. I say that most fraudulent companies are a subset of financially vulnerable companies, and these fraudulent companies are held up as example of why short selling is valid. Let me repeat that: Short selling attacks financially vulnerable companies, and fraudulent companies are a subset of financially vulnerable companies.

   

That’s it. That’s all there is to it. Short selling is just a way to extract profit from a weak and vulnerable company. Do you know what the weakest and most vulnerable companies are? Capital intensive startup companies that are developing novel engineering or biotech solutions to major problems. You know, like curing cancer, or developing new EV/renewable technology? That’s right, the overwhelming majority of shorted companies are biotech companies and EV companies. These companies all have negative revenue/earning, and use the stock market as a way to fund their research, development, and manufacturing, so that they might be able to develop lifechanging solutions to the world one day. These companies are prime short targets not because they are fraudulent, but because they are financially vulnerable. COVID, a once in a lifetime event, was like taking candy from a baby from Citadel and friends: it provided a treasure trove of shortable vulnerable companies in the form of commercial strip mall companies (hello GME!).

   

Next up, I will prepare a post explaining the specific mechanics that make capital intensive startup companies prime targets for short selling.