It is the holiday part of the trip and I was strolling through the back-lot footpaths of Venice with my twelve year old son. We were doing out best to get lost (surprisingly easy) and I had given up worrying that my wife had (dangerously) gone shopping.
It was four hours chatting to the boy about business and history and life without the interruptions of computers, phones or video games.
We talked about the trading history of Venice, the closure of the Venetian constitutional system (La Serrata of 1286 to 1297) and the subsequent relative decline. We talked about the expenses of the nearly endless series of wars against the Ottoman empire.
We even mentioned the rise of double-entry accounting. We got as far as the collapse of the Venetian State at the hands of Napoleon.
We also talked at length for the first time about our business. We run a hedge fund. Our job is simple: make rich people richer through investing, trading in financial markets.
Half of that is relatively easy to explain: we buy shares in good companies. My son wanted to know why I was not interested in buying Facebook (he thought the shares are going up). I told him that it had 4 billion in revenue, 1 billion in profits and a market cap that was likely to edge 100 billion. The numbers are from memory (I am on holidays). That seemed expensive. However it was only about $200 per regular user which does not seem so expensive. I did not think I could analyse it well. This was the beginning of a discussion about price.
But then the area our fund is best known for came up. I am a short seller.
I went through the mechanics of short-selling. I borrow a share from a broker. I sell it in the market. If the stock goes down I get to buy it back for less than I sold it. I repay the loan by returning the share and I keep the profit. I explained it does not work so well when the stock goes up.
Then I got to the nub of the issue: I am a short-seller of frauds and stock promotes. I look for people in the stock market who have fake accounts and who are stealing from gullible shareholders (also known as marks, dupes, fools, day traders or mutual fund managers). There is a torrent of money being ripped off (many billions of dollars for instance in the case of the Chinese frauds a surprising amount of which came from Fidelity). Through short-selling I stick up my sail on my little boat in the hurricane of theft and some of that loot drops into the cabin.
He asked me how I find all these fake accounts and fake companies and I told him a few of our methods (we have many).
He asked if I ever dobbed the scammers in to regulators and I said I did sometimes but it was mostly not a satisfactory experience. To be a good short-seller I only need to be right about 90 percent of the time. If most the companies I short-sell have fake accounts I will do fine. However if I dob them into regulators I need to be absolutely right in that it does not bode well to dob an honest person into the authorities. So mostly I keep my gob shut and express my opinion (and it is an opinion) in a bet in the financial market.
Moreover talking about which stocks you think are frauds is a dangerous thing. Regulators sometimes (even foolishly) have been known to investigate short-sellers for telling the truth. (Being short Lehman Brothers and vocal about it was a good way of getting an SEC investigation for talking truth to power.) Also crooks sue short-sellers giving you nasty and expensive legal bills.
Silence is altogether a better strategy.
But then he came to the nub of the issue. The easiest scammer to find is a repeat offender. We actively seek out people who promote dodgy stocks and who who are repeatedly involved in dodgy companies. The slogan is “once a scumbag, always a scumbag”. That slogan is probably not strictly accurate - but we only need to be right 90 percent of the time to be fantastic at this business – and the recidivism amongst scammers is surprisingly high.
In that sense long sentences for people like Bernie Ebbers are not in my interest. I would prefer slime-bags to be back-in-business rather than in prison. More opportunities for me.
So, perceptively my son asked whether it was in my interest to dob scammers into regulators – he asked whether the reason we did not do it much was because of the reasons stated above or because we liked the scammers to be free and profitable. Alas – and I had to confess it – at least part of it was that being a successful short-seller required that regulators were inadequate to the task of policing fraud.
I did not talk about this with him – but it is becoming harder under Mary Schapiro. The SEC is getting better at their job – and that is not good for me. It would be better if regulators stayed hopeless. Alas they are getting better.
So, says my son asks you like nasty people to steal from poor investors, mutual funds (and he did not say pension funds for school teachers) so that you can join them in taking the loot by being a short-seller – and you don't want the regulators to do anything about it because there are more opportunities for you?
Sheepishly I confess yes.
And he says with a mixture of admiration and horror: “daddy you are more evil than I thought”.
John
PS. A long time ago I promised Felix Salmon an economic defence of short-selling. I did not deliver – but it is sort of written in my head. I think I owe it to my son too.
37 comments:
John,
Thanks for sharing. That must be quite a moment for a dad. You have a sharp kid!
All you have to do is point to the numerous instances in which frauds would have grown a lot larger than they did, and cost investors a lot more money, had they not been brought down by short sellers.
It is fortunate you indeed do have a meaningful - financial - incentive to pursue fraud, for the State authorities have no meaningful motive.
(Jesus, Google/Blogger - captcha, then I realised I need cookies on for blogger, try again, takes me to Google to log in, try and fail, ah, need cookies again but now for Google, try again, it fails and takes me hack now to the original comment submission form. Annoying headache. Repeat for third time now everyone has the cookies they need).
When I saw the headline, I was convinced it was going to be a negative post on West Palm Beach rto magicjack vocaltec (CALL). I'll leave the company specific due diligence to you (what is going on isn't too hard to figure out if you look at the company's on again off again (and on again, sort of)stock offering, the new President hire and COB resignation), but here is the "daddy connection:
http://deadspin.com/5881298/dan-borislow-told-his-players-to-call-him-daddy-and-other-tales-from-a-miserable-magicjack-locker-room
For those living in my part of the world (NYC) who need a translation - a "Dobber" is a "tattletale".
Usage:
He's a Dobber
I dobbed him in
No dobbing allowed
The "economic defense of short-selling" ought to be combined with an "economic defense of long-buying." It's only fair.
JM
John needs to add a Dr Evil laugh at the end of the post to make it complete. Thanks for educating all of us.
John,
you kind of fell to shifting the burden thingie here. Frauds (and subsequently shortsellers) are not taking money from "school teachers" and "poor investors". They are taking money from people who either possess quite some or are trusted by owners to manage "quite some". Responsibility to hold (and increase) those are on them and them alone - not the regulators and not stock companies.
The whole topic arises from the inherently flawed but common assumption that "as normal", stocks should be profitable. E.g. wouldn't scammers defraud "poor investors", that investors would be "entitled" to hold, and increase, their invested wealth.
OK, people would cut back here "more profitable then with scammers, anyways", but that's already a surrender. Cuz nop, not even that.
So I think to really do economic defense of short selling you will likely have to go very deep down the rabbit hole of stock market fundamentals :) And yep, you will likely have to touch long-buying aswell and explain what value that creates.
For example, one of the ways to look at it is, added value. Shorting requires work - and work is what produces value (ok "opinion":). Buying and holding should theoretically require work, but by the availability of stocks for short burrowing you can see that work is not always being done. In truth, that work is rarely done at all, because "it's not normal for stocks to dive"(?!) Now where's value in that? :))))))
Regards,
Dmitry.
US congress seems to be condoning fraud now:
http://www.reuters.com/video/2012/04/13/jobs-act-is-fraud-made-easy-sam-antar?videoId=233309052
all in the name of capital formation.
You talked to a 12 year old about the Venetian constitutional system during a vacation???
You talked to a 12 year old about the Venetian constitutional system during a vacation???
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yes. I am a geek.
John,
First, a hearty 'LOL'. Second, how old is your son? Third, I have an alternative take:
A short seller is at best an avante-garde superhero (financial) crimefighter, such as Batman, or at worst, a vampire slayer (that occasionally feasts on vampires or derives joy from slaying them).
While DC COMICS would lead you to believe that Batman and Superman's counterparts, Bruce Wayne and Clark Kent, don't have to worry about real world concerns, such as earning income, paying bills, getting sleep, etc., real world superheroes usually need all the above.
While I understand the inherent conflict(s) of interest you identified - namely that we as short sellers have more promising prospects/opportunities, the more forgiving regulators and law enforcement are to the crooks (which you so correctly pointed out that we 'love' repeat offenders) - I'd like to point out the following:
1) We're not causing nor helping repeat offenders repeat their evil ways... they are given the chance(s) to learn from their mistakes, and walk the road toward redemption. Some do, some don't. Recidivism among the crooks is outside us short sellers' hands.
2) even if we were to actively aid regulators and law enforcement to try to get harsher sentences/fines/etc. for repeat offenders, I'm skeptical that alone would be an effective deterrant. Take the drug trade in the US for example. Despite far lower risk-adjusted payouts for selling drugs than for stock fraud, the supply of offenders seems quite high n steady. Said differently, I fear the opportunity set for shorting frauds would still remain.
3) you may sheepishly 'like' for evildoers to roam free and continue their misdeeds... Why can't you be disgusted on one hand that the world is the way it is, yet on the other hand, accept it for what it is, and try to make it a better place... meanwhile receiving compensation for your labor and various risks you bear. Not to mention, regulators/law enforcement have finite resources, and are sometimes less equipped to fight the crooks head on than we are. They and the world need us.
Perhaps you should tell your son that you're a crimefighter in the way that Batman is :)
Perhaps you should have used the daily mirror check.. if you were not impressed by what you saw, then change.. itcould have given you the opportunity to impress your son (in a positive way).
A successful short seller is like a successful bacteria or virus. It is not in the interests of the bacteria or virus to kill its hosts too quickly, or at all, as that would limit its ability to grow. Your son has hit the nail rightly on the head!
However, typical bacterial or viral strategy is better attuned to longevity and success than one adopted by a particular species intent on servicing its needs regardless of increasingly damaging costs to its own host.
Great job Dad! On a number of fronts - talking history to teenagers, engaging in meaningful conversation with substance and total honesty.
Not sure I'd waste my time explaining anything to Mr. Salmon.
Truly an enlightening blog post.
As far as the SEC getting better, that's true of the enforcement division but not Corporation Finance. Look no further than David Baines' 3 part (thus far) expose of the Sunpeaks' p&d.
Great article. I was just re-reading Sold Short by Asensio which he gave me when I heard him at the Harvard Club NYC in 2000. What happened to him confirms everything you say about the regulators and reporting fraud to them if you are a short seller. Likewise the enormous legal bills in defending lawsuits launcehd by the crooks against you.
You obviously raised a really smart kid. He is already far sharper than the gullible investors you mentioned.
Tom L
Short selling is fundamental to a free market and most of it occurs with put options. Regulators are better off enabling short selling as described which enhances more accurate price discovery. However naked short selling should be disallowed to reduce the opportunities for manipulation by the big traders.
I predict a splendid financial career for a 12 year old boy.
It's the "mixture of admiration and horror" that explains all. Your son is perhaps appalled by your actions, but realizes – as you do – that doing bad leads to more financial gain than doing good. We all do that.
Above all, it sounds like your son is smart enough not to join the stock market racket in the first place. I'm in it, and love it, but hope my daughter does something more meaningful with her life.
Short-sellers provide liquidity, add to price discovery, and are the only ones interested in mitigating the damage from bubbles by attempting to prevent them from growing ever larger.
ezpz.
John,
when is your son setting up a short fund?
John.
In an ideal world, fraud would be so painful that it practically wouldn't exist. We probably aren't in an ideal world. If we want to move closer, the post above makes clear that:
(a) Regulators, as they currently exist, are very unlikely to do the job.
(b) Short sellers, as they currently exist, are also unlikely to do the job.
Your son sounds like a smart cookie. Why don't you ask him if he has any ideas for an option (c)?
All the short sellers above that are too busy justifying their source of income to question whether there is an alternative, please abstain from commenting.
Good entry. I follow your blog a lot John. I give you a lot of credit in being short bias. I have always had a natural ability to spot dislocations in the market (not just equities) and be able to put money into those areas along with being able to identify certain trends that are not of popular belief.
Short selling those takes a certain talent. I've tried it before but it never came naturally and I wound not making money in that area. Short selling in general is IMO a tough way to invest vs. other methods. To each his own.
The history lesson probably should have covered the new shipping routes to the Indies (eg by Vasco da Gama) opened up from about 1500 and the consequent erosion of the Venetian economy.
Yes, Napoleon certainly gave those Venetian bastards the coup de grace, but by that stage they had been in decline for nearly two hundred years.
The parable i was thinking of was more akin to robin hood than batman, although instead of taking money from the fraudulent rich to give to the poor, the monies accrue to ...the rich. So the taking from the fraudulent rich bit engenders some social justice. You just need the equivalent of giving to the poor to make the loop complete.
I am just impressed that you could get a 12 year boy interested in double accounting, while on vacation.
To be fair, Minecraft is pretty awesome.
As a parent I understand what it is like to be judged by my children and found wanting. I managed to keep mine fooled a little longer than 12 years.
I am reliably informed that we get them back at 23.
one issue you dont touch on is that of suspended trading of a stock - its not in the short sellers interest if a stock gets suspended for a LONG time
Thanks for your thoughts, I'm going to have to go back and read everything on your blog now.
I always thought that shorts were a subcategory of arb trading. You have a spread between regulatory oversight and enforcement.
And just as the typical arb trader is interested in not solving the systemic cause of that spread, the short seller isn't interested in solving the (appalling) deficiencies of government regulation.
I'm impressed with the way your son followed the logic trail all, on his ownsome. Bright boy.
By the way, did I tell you about my trip to Venice. It was half a dozen years ago, and before we left I looked around the shops for a souvenir.
I was looking for a small portrait of Alviso Mocenigo I, the Venetian ruler whose fleet of over 100 galleys formed the nucleus of the Christian forces which defeated the infidel at Lepanto, in the last great battle of oared vessels.
At last I spotted one in an art shop window - a print of Andrea Vicentino's "King Henri III (1551-89) of France visiting Venice in 1574, escorted by Alvise Mocenigo I"
As I entered the shop another customer came in, and reached the counter before me.
"Excuse me", he said, "how much is that doge in the window ?"
Maybe your father should talk to you about community. It's not always about the individual. Sometimes you have a duty to the larger society.
Been a while since I've looked at this blog - came here to check if there's any mention about the juicy media event of London Whale and lord Voldemort. I guess my feeling it is too juicy to be true is just evidence of my paranoia. But this blog is as inspiring as it has always been.
Some comments: John seems to have a pinch of self-doubt or something in that direction as this post seems to circle around the moral aspects of short-selling. Many of the responses seem to be in the vein of if it is legal and makes you money, that can't be wrong. But often the issue in moral dilemmas is not about legality. The question is about goodness. And there is clearly a question to be asked here. A person with a conscience will ask how this work I am doing is contributing to the world? Am I helping or hindering the world in becoming a better place? And short selling definitely is an interesting activity in this respect: it is both destructive and constructive. The stock answer of this makes money so it must be good - all in a days work for a predator just doesn't answer the moral dilemma.
I look at this from a bit different perspective. I think in ancient Japan wearing a sword meant you were a member of the warrior caste, which implied you were willing to take up a challenge if one came your way. And that meant being prepared for the battles all your life. A warrior's life. That lifestyle doesn't exist anymore. But to me the stock markets seem a bit analogous - the participants are expected to know what they are doing. Simply knowing you can lose all your money in the stock market is sufficient. What participants then do is their choice: certainly there were lousy samurai who didn't want to practice the martial arts and then didn't live to tell their story.
But I'd like to add another twist here. Winning may be one part of the game, be it stock or swordfight, but I don't know if just wanting to win makes good warriors or good investors (or good lives). A good warrior is one who enjoys the practice, enjoys the battle, and takes care that he can survive to fight another fight - because he likes it. So in this perspective, being a winner doesn't mean that much - the question is, do you enjoy the lifestyle? The shrill voices declaring that I'm still winning may be the voice of those who cannot find joy in the lifestyle, so they have to invent a measure to tell themselves they are having a good time. A warrior has to live also with the reality of having to meet and kill in battlefield men that may be more worthy than he is. That is also a part of being a warrior. Not being willing to take that responsibility means finding another job.
Having a conscience and the instincts of a warrior may be a complicated psychological constellation to have. But in this area, I think Nietzsche spelled out something that our culture needs to face somehow at some point: going beyond good and evil. And Jung was a follower of Nietzsche in this respect. This would be quite another story to pursue, but I'll say this much: It is possible to have a perspective on reality that is not working at the dualistic level of good/bad, reward/punishment, right/wrong, winning/losing. All of the goodness, reward, rightness and winning will not satisfy, because the possibility of getting the bad, punishment, wrongness and loss is always there. With duality, one never arrives. So I've decided to concentrate my efforts on the things/experiences of joy where duality doesn't arise. But this also means one has to renounce the search of moral high ground. I have choices, but they are not about good or bad. Being a warrior in the market may mean some orpahns and widows will be trampled (thanks to their no-good hired "professional" help). This may be unhappy. But being a warrior who works as a toilet-attendant to be good and hold the moral high ground is the true misfortune.
...continuing
I'll also comment another post from earlier about the housemaid living under the stairs: something that did not arise in comments was what kind of person is this housemaid? She may be the equivalent of Einstein in intellect, but if she has had no possibility for any training beyond household chores, she will have to contend with excelling in those. That may be good for her employer, but I don't know if that is a good way to use human resources. There's a tendency to consider people doing menial tasks to be born into exactly that position. As if they are not capable of anything else. I have myself worked both in menial jobs and high-paying jobs and I do notice there is a tendency amoing high-paid/successful people to perceive their postition as something they deserve because of their superiopr skills and qualities as humans and professionals. It can be so, but personally I have not noticed any superior qualities in so-called successful people. Scumbags an assholes exist both in high places and low (as do saints). There are people whose skills are best suited to being housemaids, and certainly they should work as such. But I do notice there is, also in myself, a tendency to rate jobs and professions as more or less valuable/important. A maid is of help to a woman having a professional career, so she can do important work instead of household duties. Why is the important work always something else than cooking for the family and having a well-kept home? Does the important work make for a good life or is it just collecting measurable success while having a life without joy?
Extremely interesting questions to ponder, thank you for the blog. Reading and thinking your texts, I feel I can also see myself more clearly.
The "economic defense of short-selling" ought to be combined with an "economic defense of long-buying." It's only fair.
This. How is it anymore ethical to buy stock from someone and take the the profit they would taken if you hadn't bought it? Do you hate poor investors and teachers?
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