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back to article Patrick Byrne: 'See, I told you America's economy was busted'

Overstock.com CEO Patrick Byrne has declared another victory in his six-year fight to expose fundamental flaws in the American financial markets. With a piece detailing what it calls "America's dodgy financial plumbing", the latest issue of The Economist addresses the very problem Byrne has fought so hard to uncover: naked short …

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This is not a title

So, in naked shorting I sell a stock I don't have access to, or own, to someone I have no intention of delivering said stocks to? In any other industry that's known as fraud. Perhaps we should be throwing these people in jail instead of giving them tax payer dollars to shore them up.

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Anonymous Coward

no

You have a certain amount of time to provide the stock, if something goes wrong (e.g. the price rises) you need to go find somebody to sell you the stock so you can give it to the person you sold it too or else you're in big trouble.

Learn before you speak.

Also the people who shorted well just read the market correctly, they said "this is a massive bubble built on credit, and it's about to collapse" and they made money out of the collapse.

The problem which people like to skirt over is people were given money they couldn't afford as it is, and especially if they lost their jobs, then they bundled all this junk together, gave it a nice name, and handed it around playing a game like parse the parcel until the music stopped. The music of course stopped when lots of people started defaulting on loans and a lot of banks realised they were holding bags of shit. Everyone is to blame for buying into the lie.

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Gimp

Market self-regulation

In a somewhat parallel (and loosely intertwined I am led to believe) market, if an important buyer is wronged and fails to receive his goods in a timely manner, traditional recourse would be to send his boys round to break the vendors' legs. Don't see why this principal couldn't be equally applied to stock trading and it should solve matters overnight.

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Re: no

Er, try it. If you call a reputable broker and try to sell shares, one of the first questions you'll be asked is; "Can you confirm that you do have the shares in question?". In order to naked short, you have to lie here and say "Yes".

It may well be your intention to aquire sufficient stock later to satisfy the call at settlement and you may indeed do so. The premise on which the trade itself was based is still fraudulent.

Shorting is a legitimate practice, but requires that you do actually have the stock you are selling (either you own it or have borrowed it - makes no odds). Naked shorting is considered "grey" in most markets and downright illegal in the well-regulated ones.

Remember here that the OP described the practice as fraudulent (i.e. "In any other industry that's known as fraud."). It is. Remember also that dependant on local legislation, not all fraudulent practices are necessarily also illegal ones.....

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Trollface

@no

If you don't believe Naked Shorting is fraudulent, I can do you a very good deal on Tower Bridge...

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The mechanics aren't like that

"In order to naked short, you have to lie here and say 'Yes'"

No, you can short stocks without owning them. That's done every day in legitimate shorting. However, the broker has to borrow the stock. In naked shorting, that step is skipped. The problem with naked shorting conspiracy theories is that brokers have no motivation to not borrow stocks. That may explain why so few actual examples of naked shorting are ever prosecuted.

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Boffin

All these deck-chair economists!

The ECB banned shorting during the crisis because everyone thought it was a major cause of it. They found no conclusive evidence and lifted the ban because shorting increases market liquidity.

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Every major study of the crisis discredits Byrne

Every authoritative study on the financial crisis makes no mention of naked shorting, including the final report of the Financial Crisis Inquiry Commission. It came down as follows; the FCIC and all the major books on the crisis (such as Too Big to Fail by Andrew Ross Sorkin), claimed that the crisis was caused by the activities of the major banks (except for NSS, which they don't mention), and the Republicans say it was caused by government policies.

Only the wackos and conspiracy theorists claim it was NSS.

One sidenote: one of the most authoritative books on the crisis was by Bethany McLean and Joe Nocera, two investigative reporters who have exposed Byrne as a crank years ago and whom he has viciously attacked on his blog.

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Anonymous Coward

Naked shorting...

"A naked short sale works much the same way – except you don’t really borrow the shares. Three days after the sale, when it’s time to actually deliver shares to the buyer, you fail to do so."

No it doesn't.

With a naked short you sell the shares with the aim of being able to buy them yourself for delivery at a cheaper price just before the settlement date (typically 3 days later). If it doesn't drop you take the hit but fundamentally still have to settle them (unless you're busy going bankrupt). That's why the scale on your graph are so relatively tiny (tens to hundreds of millions) compared to the huge volumes actually being being traded daily.

Compared to the picture that graph paints naked shorting is less dodgy, but would also be much more prevelant.

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Yes. But.

I thought the point was that after three days you 'could' default and not suffer any consequences other than having to give the money back. If the company in question has gone bankrupt you don't even have to give the money back. So if you like the game you can deliberately kill companies for fun and profit.

That's got to be a bit destabilising isn't it.

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Actually, no

1) You can't just default without consequences - there are legal obligations on you and on your broker.

2) Can't kill a company (especially a small one) in 3 days just by pushing it's stock down. Stock value on secondary market has no direct impact on the company's cash flow. If the company in question has stock-related covenants to its banks they are usually averaged to a reasonable period of time - a month, a quarter etc.

If you sell massively and can't deliver in 3 days the price will just bounce back...

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Headmaster

Fail fail

Failures to deliver, shirley?

Especially confusing if you don't highlight the phrase in some way. See Para.7

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Big Brother

But is it actually a problem?

It's not naked short selling that is the cause of the economic collapse, and I would hope people have an idea of what is the root problem by now [http://mises.org/daily/5150/Fear-the-Boom-Not-the-Bust].

So you have a naked short seller - do his activities actually hurt the companies the publicly traded stock of which he is mishandling? Does he have enough presence to make appreciable dents in said companies' stock price? Won't other traders notice the persistent "failure to deliver" activity of the black sheep? Should we care [http://mises.org/daily/3066]

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Headmaster

Yes it is.

>"do his activities actually hurt the companies the publicly traded stock of which he is mishandling?"

Yes they very clearly do.

Any further questions?

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Anonymous Coward

Von Mises ...

... a man who had a problem with the civil rights movement.

I'm guessing none of you ultra-right libertarians care about anything at all.

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Holmes

Without validating the veracity of either statement

Ahh yes because people that have misconceived ideas in one area are never worth listening to in another wholely unrelated area.

Classic ad hominem.

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We need to slow things down

A major problem now is that the stock market has become a casino - the basic premise is excellent: businessperson has idea, needs money to develop idea, person with money invests in business in exchange for a share of the company, reaps rewards in form of dividends and, maybe, one day sells the investment ('shares') for a profit (or loss) - all long term stuff and directly linking lender and borrower. Both have an interest in making the company succeed.

Present actual system is very different - people trade shares and try to make money on fractional percentage points of increases/decreases in value, and have an incentive to short sell and manipulate the market. They have no interest in the actual company and whether it is a success or a failure - they don't care.

Several simple things could help this - simple, but totally unacceptable to the governments and 'regulators' who have a vested interest in the status quo.

1) The tax on transaction proposed - say a 2% tax on all share deals, payable by the buyer. Not a problem for a long term investment when you're planning to hold the shares over years (and it could be refunded if the shares are held for say 12 months.)

2) Slow down the whole trading system - computers are great but the ability to trade in micro-seconds encourages the gambling and short selling. Let's make the stock market a real market, where people exchange money for real things, like buying a couple of pounds of spuds from the local market stall. To buy shares you should have to find someone who wants to sell (websites could help here) - who must be the registered holder of those shares (i.e. holds the physical printed share certificates in their name). You then give them money (real money, transferred from one bank a/c to another, possibly via an escrow a/c for security), and then the sale details are registered with the company (by completing the transfer details on the paper certificate and returning it to them - like selling a car) and new certificates issued. Only then is ownership transferred, allowing the buyer to re-sell the shares. Wipes out the whole short-term buying/selling on margin and not having to pay until 'settlement date' silliness.

I really should be Chancellor of the Exchequer! Economics is very easy if you stick to reality....

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Yes, but

where's the coke-snorting hooker-banging fun in that?

The whole point of Wall St is that it's a casino for teenagers who refuse to grow up.

It's the world's biggest MMPORG, with the best conversion rate between fake play cash and real cash, and none of the high camp of WoW or Second Life.

It's all adrenaline and cortisol all the time. Screwing the system and screwing the customers in every possible way is considered a feature, not a bug.

If you pressure these people to act like moderate and rational adults who understand what consequences are, they'll call you a socialist and run you out of town on a rail.

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Pirate

Unfortunately...

A lot of people make a lot of money from the current system. They have "very close ties" to the people who make the laws that govern the system, which strangely enough tend to change in ways that make it easier for them to make money.

Little details like financial stability, or relevance to the real world, are somebody else's problem.

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O-oh..

"Slow down the whole trading system - computers are great but the ability to trade in micro-seconds encourages the gambling and short selling. Let's make the stock market a real market, where people exchange money for real things, like buying a couple of pounds of spuds from the local market stall. To buy shares you should have to find someone who wants to sell (websites could help here) - who must be the registered holder of those shares (i.e. holds the physical printed share certificates in their name). You then give them money (real money, transferred from one bank a/c to another, possibly via an escrow a/c for security), and then the sale details are registered with the company (by completing the transfer details on the paper certificate and returning it to them - like selling a car) and new certificates issued. Only then is ownership transferred, allowing the buyer to re-sell the shares."

Let's start with banning electronic communications - all messages must be hand written on pieces of paper and personally delivered to the addressee. This of course is as ridiculous as what you propose for financial markets.

"Wipes out the whole short-term buying/selling on margin and not having to pay until 'settlement date' silliness."

The world existing in your imagination is quite detached from the real life...

"I really should be Chancellor of the Exchequer!"

On the second thought - better not.

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Um, having once upon a time actually bought and sold some stock,

#2 is exactly how it does work, except they've made it fast. margins and shorts are legitimate investment tools for those savy enough to use them.

As for the whole casino thing, no actually they haven't. The professional traders, the ones who CAN actually work with the mico-seconds trading, all work from complex programs designed to take the risk out of the investment. It's complex math stuff that's way over my head, but it is real and I've regularly read stuff from one a guy who writes the stuff. He called the collapse of Lehman Brothers about a week before it happened based on fundamental problems in the market, and had made the broader prediction that some company in the LB sphere of activity was going to collapse about a month before. Smart guy, and right now he's worried about Greece and the refinancing deals.

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Bah!

Here in New York we have city blocks of these professional traders you speak of and my pension fund has taken a steep dive partly through their "understanding" of "how the market works". Most of these people have never seen a real depression in operation and so are ill-equipped to lead us out of this one.

I don't care if you risk your money. All I ask is that mine is risked to the extent I agreed to when I signed various contracts with your brokerage. Buggering about in the fashion that Wall St has been doing for thirty years has damned near brought the USA to its knees financially speaking, beggared the country for generations to come and just about proved to the world that the American Economic Model is fundamentally broken. Everyone involved should be horsewhipped around Battery Park for that alone.

And for the obvious day-trader who keeps coming out of the woodwork to rant: Naked short selling is an artifact of the inadequacies of the electronic systems you are singing up - inadequacies that in any other field of enterprise would be called "bugs", "faults" or "glaring and inarguable proof of incompetence and reasons to activate the Force Majeure clauses in our contract with you". The electronic systems in question should either be brought into proper operation to eliminate this insidious menace to the economy or the practice should be legislated out of existence.

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IT Angle

I know it's not popular to ask these things, but...

...what's the IT angle here?

If this was a deficiency in the backend trading infrastructure, it would make more sense as an El Reg article. Short selling == IT. Just sayin'...

oh look, I've been downvoted.

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Anonymous Coward

He is wrong

Greed is good - The Almighty Thatcher said so, and that is proof enough for me.

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WTF?

so in plain EngRish

am I understanding this correctly?

Short selling is:

1) You borrow 100 shares

2) you sale the 100 shares at 10 dollars each (1,000 dollars)

3) wait for the share price to drop

4) you buy back the 100 shares at say 8 dollars each ( 800 dollars )

5) you give back the shares you borrowed

6) you made 200 dollars

the only problem is... if in step 3 the price doesn't drop, but rise, in which case you end up losing money

naked short selling:

1) you skip the borrowing part, you simply tell some poor soul that you have 100 shares

2) you sale the none existing 100 shares at 10 dollars each (1,000 dollars)

3) you wait for the share price to drop

4) you buy the actual 100 share at 8 dollars each (800 dollars)

5) you deliver the shares you sold earlier to the poor soul who just lost 200 dollars

6) you made 200 dollars from thin air!

the problem is, in step 3 the price might not drop, so you simply tell the poor soul -that you tricked- that you can't deliver the shares and that they can have their money back.

is my understand correct? if it is, how can the seller get away with not delivering anything after collecting the money and keeping it for 3 days? Also, how does this effect the company stock?

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Absolutely.

In answer to your question. The company in question can take a massive hit because there is not limit to the amount of shares you can 'sell' if you don't actually have to own or borrow then. Also if the company takes a hit so bad they go bankrupt the you don't have to bother with steps 5 and 6, you just keep all money.

Try a trick like that with at the bookies and you'd better hope the police get to you first.

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Devil

Seems that way.

But there's more. At step 3 the company stock might not just devalue, it might go completely bankrupt (thanks to the falling share price you're helping to drive down).

Now even if you did have any shares to sell (which you don't), they'd be worthless. So you get to keep the sucker's money and don't have to deliver anything at all.

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IT Angle

Not quite

a company doesn't go bankrupt because its share price declines (even significantly).

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WTF?

It does if the bank notices and calls in some loans.

Or its customers notice the panic on the trading and similarly panic and go elsewhere.

Depends entirely on the nature of the business, but there are plenty that live and die on their share price.

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The naked short sale in and of itself cannot bankrupt a company.

In order to bankrupt the company, you have to have outstanding loans or lines of credit which tie their availability to the share price of your company. Then either the loan gets called or line of credit on which you have been depending is closed and you can no longer operate.

If you want to go down the conspiracy trail to people using it to manipulate the market, that's a very scary place filled with ghosts, lichs and worse. Because in order to use it to manipulate, your talking about the kinds of resources that only become available at nation-state levels. Or maybe Google, but not a consortium of stock purchasers.

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You missed 1a in a normal short.

1a: You provide your broker with an account that has some percentage of money equal to a typical price move for the stock in case the value of the stock goes up. This money will be used to cover your short if the price doesn't fall. If your cover account gets a call because the price of the stock has gone up too much, you have to put more money in the account.

Selling short is generally regarded as something only for professional grade investing, because unlike a long buy, you have unlimited exposure if you are wrong about the direction of the stock price.

My understanding is that for a naked short you have to borrow the full amount of money plus the cover.

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Bah!

You missed a step - the one where you park the non-existent phantom stock in a hedge fund that forms a major part of a pension fund for (say) an auto manufacturer.

The assumption being that said manufacturer will end up defaulting on the pensions so (in Wall St parlance) "No -one gets hurt".

It's a victimless non-crime! Money from nothing - The American Wet-Dream!

(Tax-payer funded) Bonuses all round!

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Meh

>"Byrne is the rarest of executives, a CEO unafraid to speak his mind"

Most CEOs speak their mind, or what they would present as the public face of their mind; the only real difference is Byrne doing it in a ludicrously melodramatic fashion.

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Happy

"....Byrne doing it in a ludicrously melodramatic fashion."

Not his fault he found himself in the midst of a ludicrous melodrama of someone else's making.....

See earlier El Reg articles about the Weiss gaming of Wikipedia, the cast of characters involved and their backgrounds. Shakespeare must be wishing he'd thought of it (even if it lacks a bit with a dog...)

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@Anonymous Coward 14th June 2011 09:17

You summed it up perfectly, this is what these scum tried to do with Volkswagon I believe a couple of years ago, unknown to them Porshe already had all the shares , so when they went to buy them, they told them to get stuffed, lot of them got hosed lol

http://business.timesonline.co.uk/tol/business/industry_sectors/engineering/article5033654.ece

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Holmes

This is rampant on Comex and it's the big fish doing it!

Big naked short players, probably JP Morgan and HSBC, routinely and blatantly naked short Gold and Silver. This is common knowledge now and glaringly obvious on the price charts, but because of regulatory capture by these same players, they get away with it while the smaller players get hammered by steeply rising margin increases when the big fishes loses get too large.

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Now you completely mixed up

Stock and commodity futures markets.

If you default in a futures market your clearing member (a big bank, normally) is responsible for your obligations towards the exchange. Clearing members will take to the cleaners if your try something like that before you can blink your eyes... Ask, if you want to know how.

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FAIL

Normally I post AC but

A couple of mis-conceptions to clear up here.

If you sell shares and fail to deliver you cannot just back out of the trade. It is enforced both by the exchange and local law. Typically if you cannot deliver you get "bought in" and are subject to interest claims. Either way you are on the hook, the only escape is typically liquidation.

@ LPF and AC 09-17. The porsche/vw thing was not the same - what porsche did was definitely market abusive and manipulative by it worked in a completely different way. in essence it was a short squeeze.

El Reg - love your work generally but this article needs a sub editor with a good understanding of finance, really not pretty to read.

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Megaphone

Fundamental issue

For simplification, Company A has sold 1,000 shares (i.e. if you own 1,000 shares you own A.)

To short sell I have to find someone with a share, borrow it, sell it, wait, buy it back, return it and get charged interest for the inconvenience to whomever I borrow it from. There is only ever 1,000 shares in existence.

With naked shorting I simply affirm that I have, or will soon have 1,000 shares of Company A. I can sell 1,000 of these shares. This means the market thinks there are 2,000 shares in Company A, halving the value of each one.

If I, clever financial person that I am, use the money from the sale of shares I don't own to buy Put Options on Company A, and write Calls for extra cash, I make enormous amounts of profit when the market realises there is a surplus of supply of the stock of Company A compared to the demand.

Should anything happen that risks Company A going up in value then I am massively exposed so it is in my interest to ensure Company A's share price is absolutely hammered. If that involves driving it out of business then all the better.

NB. This, like 1984, is not a How To manual.

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Boffin

virtual shares ...

> With a short sale, you borrow shares from someone else and promptly sell them of .. Three days after the sale, when it’s time to actually deliver shares to the buyer, you fail to do so ..

I'm confused, what happens to the money you got from "selling" the shares. Isn't there a penalty for not delivering the shares, don't you deliver the money earned from the sale of the shares back to the buyer ?

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Anonymous Coward

People seem rather confused here...

Shorting a stock is just the flip side of going long (i.e. buying) on a stock. It incentivises trashing the reputation of the company in question just as much as being long incentivises talking it up unduly (the basis of the old 'pump & dump share scams').

The problem with naked shorting is it removes the normal checks & balances from the process, and again it has it's own 'long' counterpart:

* You can potentially sell far more shares than people are willing to lend you, or even possibly exist, in the time between trade & settlement.

* Similarly, you can just as easily commit to buy far more shares than you actually have the money for, with the hope of the price rising and you being able to dump them back at a higher price a few days later. You could call this "naked long'ing", but that might be confused with other activities... The control/safety net here is the fact that can only buy what shares are on the market so there is a theoretically limited upside...

In practise, the sheer amount of trading needed to ever push the 'more shares than exist' threat combined with settlement windows of typically 3 days means I can't really believe that's much of a real-world problem...

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FAIL

Do not fall for this con man.

Overstock.com's misfortunes have nothing to do with "naked short selling" and everything to do with a CEO who stood watch over the destruction of nearly a quarter of a billion dollars worth of his shareholder's equity. Go to the SEC's EDGAR site. Download any of the 10-K's or 10-Q's filed by Overstock.com. And check out the balance sheet to see what I mean.

No company, anywhere, ever, has been put out of business by "naked short selling". The naked short seller story is a red herring, used by crooked promoters and inept managements, to divert attention away from shoddy financials and executive misconduct.

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Not he alone

Somehow, in every market there are people who take a massive punt themselves, lose a lot of money and all of a sudden have an epiphany moment which tells them that it was all others' fault and the system is broken...

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FAIL

One glaring issue in this article

Something I just noticed: Byrne says he had nothing to do with the Economist article. But a man named Wellborn from the "Haverford Group" is quoted prominently.

Byrne owns the Haverford Group, and it is an affiliate of Overstock. http://people.forbes.com/profile/patrick-m-byrne/61105

The lesson here is that absolutely nothing Byrne says can be taken at face value. That''s been his record and is why his reputation is quite as poor as it is.

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Vlad hits his mark

Actually, Vlad, there is this thing called "data", which shows that people actually do.... precisely what I have for 6 years been saying they do. Does not matter how much personal invective you fling, it does not change that data.

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You Minions of Sith need a new script.

Overstock has become a $1.1 billion pureplay Internet company, with Net Income of $8 million in 2009, and $14 million in 2010. 2011 is not over, of course, but our last stated results showed a $35 million trailing twelve month operating cash flow.

To the outsiders reading this: These Chewbacca Defense towel boys show up whenever the wig starts to slip, and the market gets revealed for what it is: a game rigged by a network of dirty hedge funds and a small number of the prime brokers who enable them.

Let that answer stand for all the objections below, mutatis mutandis, of course.

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FAIL

Naked shorting is a diversion: Overstock is in deep trouble.

Byrne has been squawking about naked shorting for years. The reason the U.S. media doesn't believe him is because it has nothing to do with his company's problems, which includes his own bizarre behavior.

Overstock is being sued by seven California attorney generals for overstating the discounts on its website. http://money.cnn.com/2010/11/18/technology/overstock_discounts_lawsuit/

It was penalized by Google for gaming its search results, causing a 5% hit on revenues. http://www.auctionbytes.com/cab/cab/abn/y11/m04/i26/s

Above all, Overstock is burdened by Byrne's reputation for talking trash, in one case making a filthy comment to Bethany McLean of Fortune. http://money.cnn.com/magazines/fortune/fortune_archive/2005/11/14/8360711/index.htm

All of this is considerably more consequential than naked shorting, to the extent that there is any in this stock.

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Sod what Byrne says...

The idea of naked shorting sounds wrong to the man in the street. It sounds like it side steps the supply-and-demand roots of capitalism. It sounds like the fat cats are getting away with criminal acts. In that way it offends both capitalists and non-capitalists. It makes the law look like it only penalises those who can't afford to buy it. In the end no-one trusts a nominal market economy. No-one trusts the legal system. No-one has every trusted politicians. Perhaps putting 'in God we trust' on US currency is just an act of desperation. There is no-one else.

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The "man on the street" doesn't always get it.

The average "man on the street" tends not to be very savvy when it comes to finance.

People like Byrne and the promoters of multiple pump and dump, penny stocks have taken advantage of this investor naivete to unload an ungodly amount of over-inflated, and in many cases worthless, common stocks.

There is no law against "naked short selling", at least not in the United States. There are SRO's that ban it in certain venues, but there are other venues where naked short selling is an absolute necessity for an orderly market. For every purchaser of a futures contract, whether it's for a commodity, a basket of stocks, Treasury securities, or single stock futures contract, someone must be on the other side of that trade. In many instances, the short side of that contract will be someone who's hedging their future production/access to the underlying asset. But in many cases, the short side of the contract is naked.

Even "legitimate" short selling bewilders many people. The idea of selling something first, then buying it later to secure a capital gain often sounds wrong to the "man on the street". But just because the "man on the street" doesn't grasp the nuances of securities analysis and management doesn't mean there's anything with our laws or our markets.

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