Are the “cool-kids” too blasé about the damaging effects of unbridled short-selling? That’s what James Surowiecki thinks, arguing that since rapid share declines can cause real operational damage to a company, it’s naive to flippantly dismiss the fears of embattled financial execs.
But the bailout of Citigroup (C) and the fresh revelations about the storm that engulfed Morgan Stanley (MS) back in September suggest that the opposite is true, that violent stock moves (which may have been exacerbated by short sellers) may have helped the company.
Take Morgan Stanley. A couple of false rumours set off an information cascade of fear, manifesting itself in wider CDS spreads on its debt, hedge fund withdrawals, and of course, severe declines in its stock. Though as Equity Private points out at Dealbreaker, today, Morgan Stanley didn’t even fall by much on the days with the highest short volume The market behaved as it was supposed to. Shorts piled in, those who were late to the trade got creamed when the stock staged a sudden reversal. Not exactly a company killer. Beyond that, as we pointed out yesterday, the stock is still that low, so there was apparently nothing irrational — even in the stampede — about the stock price.
What’s more, the ability to short the stock is an important pressure releaae valve for the market. This is key: If you were doing business with Morgan Stanley, your ability to short the stock was a hedge. Say there had been a short-sale ban, or an uptick rule making it hard to short What else might you have done? Well, you might have severed your relationship with Morgan Stanley even faster, accelerating the run on the bank. Or you might have bid up CDS to even more dizzying heights. Or you might have stopped writing Morgan Stanley CDS, prompting others to de-risk in some other fashion.
As the panic about Morgan Stanley spread — through emails, word of mouth, and market quotes on various instruments — there’s little evidence that the specific ability to short Morgan Stanley shares is what exacerbaed the information cascade.
Beyond that, the whipsaw share price plays an important role in financial oversight. Whereas hedge fund withdrawals and CDS arrangements are played out behind the scenes, the stock price is available for all to see, easily. Thus there was no way to hide the accelerating run on the bank, or the false rumours making their way from trading desk to trading desk. The share price is a visible, easy-to-read thermometer. When someone’s temperature drops from 98.6 to 93.0 and then back to 98.6 in the course of a day, you know something extraordinary is going on. Banking regulators are then able to perform their triage.
That takes us to Citi, where a similar situation played out. We kept hearing during the stock price decline that it was irrational and that it was just nefarious shorts toying with the company. Well, not so, as we learned in the WSJ today:
Inside the government it was far from clear that action was needed. Citigroup’s stock price was tumbling, but there was no sense the company was in danger of failing. But over the weekend, as they pored through Citigroup’s books, it became clear to top officials that the company needed government help.
Now that it’s put that way, it’s a good thing the share price thermometer was working at Citi and the government came in when it did, before a run accelerated and the balance sheet deteriorated further.
Perhaps the title is an exaggeration, maybe shorts didn’t save Citi and Morgan Stanley. But when you consider the importance of short selling as a pressure-release valve, and the value of an accurate stock price in gauging a company’s health, there’s just as much reason to think that shorts helped the two companies, as they did harm them.
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