Let me first establish my bona fides. Here’s an excerpt from an article I posted on financial site Seeking Alpha more than ten years ago:
The time has come to ban all naked short-side derivatives. The only way to take a net short position on an asset should be traditional short selling. Everything else creates too much moral hazard.
Some short sellers are scumbags. They short stocks then publish hit pieces about them, driving the price down, where the shorts can cover. There’s nothing wrong with what these noisy shorts do in principle. If a stock is terrible, shorting it makes sense, and telling others that the stock is terrible is a service to them. If you accuse one of these shorting “analysts” of bad behavior, that rationale is their first (and only) defense. Yet, any analyst who is short (or long) a stock they are writing about has a conflict of interest that demands a more judicial style of criticism, and for some short-sellers, such fastidious journalism does not get the job of driving down the price done.
Thing is, that’s just some short sellers. Most short sales are simply bets by people who believe that a stock is overpriced. Stocks can get overpriced in lots of ways. Maybe there’s too much enthusiasm for the company or its industry. Or maybe the company’s price has run up and longs are “playing with the house’s money,” or don’t want to take a tax hit on a sale. For whatever reason, people tend to hold onto shares too long, and so there naturally emerges a group of other people who will drive the price down to its right level by borrowing shares from longs and selling them to new players.
Serious short-sellers are the financial ecosystem’s carrion birds. We don’t like carrion birds. They don’t actively contribute to the economy, even though they provide an essential service. The long investor allocates capital among users of capital. The short investor merely tidies up the market. It’s a dirty job, but someone really does have to do it. And, because the current attack on shorts by Reddit’s WallStreetBets interferes with that essential service, anyone who understands the role of our capital markets should be alarmed by the disruptive GameStop fiasco.
How is GameStop disruptive? It is disruptive because “legit” short sellers cannot risk shorting bad stocks if the crowd at WSB may decide on a whim to drive that stock to the moon to squeeze someone they don’t like. In that environment, shorting bad stocks becomes too risky, so bad stocks…