01
Feb
2021
BMS ep 178: Tom Woods and Bob Discuss the GameStop Controversy
Note: The bulk of this episode is a re-run of my appearance on Tom’s podcast. However, at the tail end I have 10 minutes or so explaining how it’s possible that there were more shares shorted than total shares.
Doesn’t short selling essentially consist of creating fiat shares that distort/increase the share supply? That’s the philosophical issue I have with shorting.
The practical issue is that when I see stocks with high short percentages, it’s often pretty obvious that the depressed stock price can potentially disrupt access to capital, make suppliers nervous (suppliers usually have 90 day invoices), and customers where applicable (if I buy input x from a firm that may go under, I will probably switch to a new supplier to avoid disruption). I’m sure it’s a small part of the shorting that takes place, but it does seem often targeted destruction and sometimes pushes a novel biotech into oblivion. WHen you can inflate the stock supply, it’s easy to do major damage to a weakened stock.
There are different types of short selling … and that’s one issue I think Bob skimped past.
If you take it as the most conservative, you first buy covered Call Option contracts. That means real shares are now locked to the contract … i.e. the person who sold you that contract does own shares, and cannot do anything other than hold them for the duration of that Call Option contract.
Now, while holding your insurance policy, you can short sell with a limited risk because in the worst case you exercise the Call Option, grab those shares and close out your short position with that. That’s the safest way to do short selling and because of the locked shares this is not some kind of fiat rehypothecation. You cannot lose more than the strike price on the options, plus whatever you paid for those options in the first place.
However, in the worst cases, people were simply selling the promise of share delivery and then depending on delays in the system so they could get away with it for a while. This might involve penalties for failure to deliver and as Bob talks about in the podcast, potentially unlimited losses.
That’s a very clever approach. I didn’t realize you could purchase “covered” call option contracts. At exercise, the calls are typically randomly assigned.
I’ve seen people saying stop losses are good protection, but there can be a big difference between close one day and open the next.
Seems like you got me on that … if there’s a mix of covered and uncovered options floating around then the buyer doesn’t know for sure whether the contract in his hand is 100% guaranteed to deliver. If there are two different products on sale there should be two different prices.
Either way … having any Call Option gives some degree of protection, but what warranty do you get, just in case some invisible counter-party gives up and throws in the towel? I’m not sure.
Hmmm … once the market is flooded with uncovered options you pretty soon have no idea what you are standing on. Let’s just hope that never happens!
I chased this up further and at least in Australia they give a lot of vague language. If you go through the PDF they give themselves plenty of discretionary powers to use in times of trouble, but all in an extremely non-comital way.
https://www2.asx.com.au/markets/clearing-and-settlement-services/asx-clear/risk-management
I have a bit of a hunch that it normally doesn’t happen and these guys aren’t so well prepared for surprise events. The ability of the stonk wonks on Reddit to coordinate large volumes of transactions coming out of left field could probably cause strange results.
That’s a big problem with financial regulation it is written to give regulators broad discretionary powers. They can pick and choose which banks to close for whatever reason they want during a crisis. The finance industry including regulators seems to be pretty incestuous, which is why I wrote the dumb joke in the post below.
DTCC which handles the business side of the clearing activity increased the collateral requirement for broker side clearing houses from 1% of the trade to 100% of the trade, resulting in a huge cash issue. Robinhood claims they were not instructed to stop new open positions, but Webull says they were told by clearing house to stop open positions for specific stocks.
The 2-day clearing time has an easy fix called blockchain.
I’m beginning to understand that the system is somewhat more skanky than I previously believed.
I found one unbeatable instrument to hold as insurance for short selling … the Call Warrant. It is backed by the company itself which has unlimited capability to issue more of its own shares. Indeed, it seems that GME should have been selling Call Warrants right into the crazy rise of their own share price.
A short seller armed with a Call Warrant has access to some agreed number of print-on-demand stocks at an agreed strike price. This insurance policy, of course, costs money upfront, and they tend to be only occasionally issued and demand a premium … which is the bad side of buying insurance.
Given that the GME short sellers were trapped they might have paid top dollar for these contracts at a higher than usual strike price. GME has the power of the printer. Hmmmm … this is starting to sound dangerously like MMT.
“There are different types of short selling … and that’s one issue I think Bob skimped past.”
You mentioned that on Tom’s site; Just wanted to share this seemingly helpful article I found on Zerohedge (I only read like 1/6 of it).
Naked Short Selling: The Truth Is Much Worse Than You Have Been Told
[www]https://www.zerohedge.com/markets/naked-short-selling-truth-much-worse-you-have-been-told
“While “long” sales mean the seller owns the stock, short sales can be either “covered” or “naked”. A covered short means that the short seller has already “borrowed” or has located or arranged to borrow the shares when the short sale is made. Whereas, a naked short means the short seller is selling shares it doesn’t own and has made no arrangements to buy. The seller cannot cover or “settle” in this instance, which means they are selling “ghost” or “phantom” shares that simply do not exist without their action.
“When you have the ability to sell an unlimited number of non-existent phantom shares in a publicly-traded company, you then have the power to destroy and manipulate the share price at your own will.”
By the way, the Fed produces naked promises in the form of fiat money, and the delays with regard to short-selling are like bank holidays before the FDIC. Those are fraudulent, too.
Yes, naked shorting is one issue I have. Hedge funds often go on for long periods of time without borrowing the shares they sold.
Even when the shares were borrowed, they were ONLY borrowed. There was no sell agreement. It’s like if I borrow your car and then sold it to a car lot assuming I can buy it cheaper later because I know the car is used and used car prices are going to go down.
But my point about shorting being like fiat currency is this: Suppose there are 100 shares. Someone borrows 10 shares and sells those shares. There are now effectively 110 shares, so the quantity of shares has increased 10%. Like expanding the money supply the value of the shares goes down apart from whatever the underlying condition is. or maybe it’s similar to fractional reserve banking?
Then there is another issue. Often, the owner of the shares does not even know the shares are being borrowed. The brokerage does it on their behalf and takes the interest payment. The WSB people discussed ways to block their shares from being loaned out by brokerages.
“There are now effectively 110 shares, so the quantity of shares has increased 10%. Like expanding the money supply the value of the shares goes down apart from whatever the underlying condition is. or maybe it’s similar to fractional reserve banking?”
Yes, both; The purpose of fractional reserve banking is to increase the IOU’s in excess (or even *increasingly* in excess) of the good that is actually owed.
In the case of increasing the supply of an already fiat currency,, that’s just a compounding of the original fraud of unbacked IOUs.
It’s effectively a promise that you will be promised something later – it’s ridiculous.
Slightly off topic, but relevant:
(Bob would disagree with this because he – as well as Mises and Rothbard – believes that an unbacked currency could function as money.
(I disagree. I think that the only reason the FRN has traded as if it were money for so long is because the U.S. has been able to trick other countries into accepting worthless pieces of paper (and now digits) as money – beginning with telling the world that the FRN was as good as gold.
Ponzi schemes cause buying and selling for as long as people don’t discover that the scheme is money-losing, or as long as they think they can get out while others take the losses.
The FRN is just a Ponzi scheme that’s lasting longer than we expect one to last; Consider that America has a gun to its citizen’s heads to force them to use FRNs (legal tender laws) and that America has told other countries that it will offer military services to them if they price their oil in FRNs (thereby exporting the monetary inflation that would have caused a more rapid price inflation in consumer goods had all the FRNs that have been printed remained in America.).
As far as I can tell, the powers that be in the United States and the powers that be in the China are in a race to see who can devalue the official, legal currency of their respective countries the fastest.
So… buy bitcoin. (Or earn bitcoin, if you prefer.) (Disclaimer: This is not financial advice, and I am not qualified to give financial advice because I don’t have one of those fancy license things. These is my personal opinion that buying or earning bitcoin is good.)
Actually, it’s technically altcoin season. But if you don’t know what you are doing with the altcoins, because of the higher volatility and all, it’s probably safer to just buy bitcoin. And if you do know what you are doing with the altcoins, you still want to have some in bitcoin so in case you picked the wrong altcoin, you don’t get wiped out of the crypto market.
Anyway, I really don’t trust banks. Just look at what’s happening in Lebanon.
https://www.elephantjournal.com/2021/02/the-biggest-bank-scheme-how-they-stole-my-money-estephan-haddad/
I don’t have any personal experience of the dodgy activity mentioned on Zerohedge, and they don’t provide a whole lot of references to work from. That said, none of it exactly shocks me.
One of the classic tricks is for the short sellers to attempt to force a sufficiently sharp dip that triggers a bunch of stop-loss orders … and if that works these will in turn inject additional supply which further crashes the price and triggers more stop-loss. There’s a self fulfilling momentum that can be generated. This is not exactly illegal, but it would be hard to claim this process represents orderly price discovery.
Every time there’s a stock crisis, someone brings up contagion. Now, after a year of Covid talk, I think I understand it.
So if one company say handles order flows for a broker, loans money to a hedge fund to keep them from cashing in their chips and pays speaking fees to officials, is that what they mean by a “superspreader”? Could this all be prevented by more social distancing?