In a 15 page letter defending capitalism and analyzing the mistakes of the government during the current crisis the chairman of Sears Holdings added a recommendation to Sears stockholders that they take time out to read some Hayek during the current crisis.
Source link: http://archive.mises.org/9516/eddie-lampert-tells-sears-stockholders-read-hayek/
Eddie Lampert Tells Sears Stockholders — “Read Hayek”
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So, pretty much, Lampert is telling the Shareholders to get out of equities because the current path of Govt intervention in this so-called “Free Market” indicates that the Gov’t will own all major businesses?
Pity he doesn’t mention Prices and Production.
I just re-read pretense of knowledge. I can’t imagine a better essay to refute the whole of modern political management!
If you want to print it, this is a better view:
http://www.sec.gov/Archives/edgar/data/1310067/000119312509038135/dex992.htm
Now is the time for people with the knowledge and certitude of classical liberalism to speak. Most others are bewildered or are propagandists. The propagandists are ambitious simpletons but the bewildered are ready for enlightenment!
From the letter:
“The sale of property (shares in a corporation) that a seller does not own and can’t deliver (naked short selling) is an affront to property owners, and a destroyer of confidence and trust.”
What are peoples thoughts on this statement?
Naked short selling is also something I’ve been wondering about. Is it similar to fractional reserve banking, in that it is a violation of property rights, or is it perfectly fine?
Must be legal, Congress and the Senate authorized the practice at the end of the Clinton’s Error.
@ Jeffery
I recommend “Pretense of Knowledge” to anyone that wants a quick read on what’s going on.
Does anyone know what the mood in the room was when Hayek gave the speech? As I read it, I can’t help but think there were a lot of nodding heads and a lot of evil looks.
As I see it, naked short selling is a form of counterfeit. It is increasing the supply of shares without any solid backing. Short selling is different in that the shares being sold were once issued by the company, and so they are backed.
I would have to agree with Greg.
There is a very good schematic on Wikipedia (as it turns out, lol) about short selling where it details the transaction process of borrowing, selling, repurchasing, and returning the shares from / too the owner and the costs involved.
In a naked short, the upper half of the diagram which includes the interaction between share holder and short seller, is bypassed by the short seller.
In essence, the short seller “creates” a share of a company (not issued by the company) to sell, sells it at a price X expecting the future price to drop some amount Y to X-Y. Before the short seller physically delivers his “created” share, he buys a real (company issued) one on the market (his hope is at a price of X-Y) and delivers THAT (real) share to the entity that bought his “created” share, hence pocketing the difference.
It would be similar to a short seller looking at your $200,000 house, offering to sell it for $180,000 to someone else without your knowledge, and then buying the house from you for $150,000 (if you agree, of course) and pockets the $30,000 difference.
This is an interesting way of looking at it, and I’ll have to think about is merits more.
So I guess options contracts are out too, then?
Am I allowed (meaning not fraudulant) to make a promise to you to deliver something I don’t currently own?
As a wheat farmer, can I contract with you to buy my wheat in 6 months time for money today. I don’t actually have the wheat just yet. And there is a small chance I will never have it.
Using his argument, didn’t I just “increase” the amount of wheat on the market?
Naked short selling is a false villain. All it is, is a contract; which is all a share of stock is as well. You can’t really steal a stock, you can only break the contract that the stock represents which would be a form of theft. I’ll back track and suggest that if the stock paper is physically stolen and it’s holder then gets % ownership, then yes stock can be stolen. But you get what I’m saying.
A question:
Does the short seller “create” a share or only portend to own a share in the transaction outlined above?
As in the house example, the short seller portends to own the house when in reality he does not.
I don’t see the naked short sale as theft or counterfeit at all.
It is gambling, certainly.
The short seller has a contract to fill. If the price goes up, he loses money. Down, he makes money.
If I tell a person I will install a hard disk for them for $100 tomorrow, and I have to go buy the disk myself to install it, have I somehow counterfeited the disk in the mean time?
Is my contract to install what I do not yet own any kind of fraud?
If I find I can buy the disk for $90, and thus make $10 in the process, have I committed fraud?
I believe the answers to these is an unequivocal “No”, and I see no reason to make a special exception for a share of stock rather than a hard disk.
Thank you Eddie Lampert!
Now I’ve got a reason to shop at Sears.
JB1122, about your house analogy, the seller not only has to offer the house for sale, but close the sale before buying it himself, which AFAIK is not possible in the real estate market.
I don’t know if selling an option (or futures contract) on wheat by a farmer can be considered naked, assuming he is insured, and is meeting margin requirements, or already holds grain in storage. Not to mention, at worst, he would have to cash settle if he failed to deliver. The stock short-seller on the other hand, can possibly help drive the price to zero, and never have to cover at all, something that can never happen with wheat.
Meanwhile, I got my 10-pack of Pretense of Knowledge to hand out to the masses. Now, if I could only find someone who reads…
BUT CONSIDER:
There is no limit to naked short selling. So to continue the house analogy, instead of saying I agree to sell my neighbor’s house, naked short selling (especially when it is coordinated amongst multiple sellers as in this most recent episode) is like putting an entire neighborhood up for sale without owning any of the houses or even living in the same city.
This can create panic (as we saw) and lead to all sorts of chaos and/or fraud.
Imagine what would happen to property values if I went into a neighborhood and put “For Sale” or “Foreclosed” on EVERY single house, all in the same day. Public perception of the neighborhood would immediately change. I could destroy the equity of every homeowner without ever having paid any of them a cent, and without them having done anything wrong.
That seems like a violation of property rights to me. Naked short selling is essentially stock market slander or libel.
The CDS market satisfies the desires of the naked short seller without violating anyone’s rights. It allows one to bet in favor of a company failing but without directly destroying anyone else’s equity in the process.
For the record, I don’t think naked short selling was the sole or even primary cause of the current turmoil. But that is irrelevant when considering its legality
MM.
Ed:
What you are saying is that this goes back into the axiom that you don’t have a right to the value of property but only to the property itself. As long as the naked short contract is fulfilled and the shares exchange hands appropriately at the end, then it is a contract that should be respected. I find myself in agreement with this interpretation, which I believe Curt is as well.
(*8?:
So what you are saying is the fact that the short seller has to close on the house before he can resell, which will notify the other potential buyer of the value really being $150,000 rather than $180,000. I concede this point, however if the second buyer has signed a contract with the short seller for $180,000 then does he not have an obligation to fulfill it? (And at that point the short seller has assumed all the risk – he may sell it at an even further discount if his bet fell through (contract defaulted) to cut his losses. Three cheers for lower home prices?)
MM:
If I make a contract to sell to someone an entire block of a neighborhood, of which I do not own any part at the time the contract was made, and then proceed to purchase it at a lower value than what the contract said, I have not committed any crime. Now if I, as you say, put “Foreclosed” and “For Sale” signs on those properties that I do not own but wish to buy at a discount and then resell, I am violating those property owners property rights. They have a right to their property which includes all of the signs on it as well (I guess someone could take advantage of the public roads, but that’s another argument for a different way to funds roads). Furthermore, as illustrated above, would I not be assuming all the risk of default from the original contract?
I still don’t like these conclusions (even mine).
I guess more thought is required/
re: naked short selling
apart from the fact that this practice is illegal, it’s tantamount to fraud.
as mikebrah says above, “phantom shares” can outnumber actual shares on issue by multiples. pricing of the security can be skewed significantly, to the point where even the future of the target company is jeopardized. if market capitalization falls below a certain limit, banking covenants can be breached, and even delisting is possible. also, certain institutional shareholders are obliged (by virtue of their trust deeds etc) to divest shareholdings in companies that don’t meet capitalization targets.
for the uninformed, please read:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aEOpTqmLZB7A
and the more exhaustive:
http://www.businessjive.com/
naked/uncovered short-selling by wall streeters has been aptly called “the crime of the century.” tort lawyers will make their fortunes pursuing those who should have be nabbed by the slobs at the sec.
(covered short-selling, on the other hand, is both licit and useful, assisting more accurate and rapid price-formation).
Naked short selling is merely promising to deliver a good at a certain price at a certain time.
If you have a seamstress measure you for a dress and pay her to make it, it is also like a naked short. The sewing better get done, although the seamstress may not have even purchased the material yet. It she can buy it for the anticipated price, she makes her profit. If fabric is more expensive, she still has to provide the dress at a loss.
If you buy a house that has not been built yet, it is the same thing as a naked short sale. The builder has contracted to build a house, and he better build it whether he makes an anticipated profit or suffers a loss (e.g. a rise in material costs). He cannot hedge house building with another house anyway since it would not be the one you ordered. A builder of custom houses must sell a phantom house and then build it.
Just as naked shorts theoretically have the power to drive down prices of stock, so too can seamstresses, home builders, and other speculators. The seamstress can advertise dresses for sale at less than off-the-rack dresses actually in the store, thus pressuring the market even though she has no dress of her own. The builder can offer to build houses for less than the price of existing homes on the market even though he has no homes in his inventory.
Those who own real dresses and real houses may cry foul and say that it is artificially lowering the value of their goods by competitors with no goods to sell. The question is whether the offer to deliver the goods is valid at the lower price, not whether the goods exist. Owners of the real goods can simply refuse to lower their prices and call the supposed bluff. Buyers can contract to buy the goods-to-be-made and test the claims. If they are true, then the real price was lower as claimed. If the claims are false, then the producers default and the buyers suffer a loss. That is the risk involved with buying future contracts versus present goods.
There is nothing immoral about naked shorts, but there is risk involved.
I don’t see why having more “phantom shares” than actual shares would necessarily be a problem. Each actual share can be bought and sold more than once. As such all the contracts can still be fulfilled, no?
Great analogies David.
selling a security without either holding it, nor intending to hold it, nor even being able to hold it because the sales are greater than the shares on issue, is a breach of the sales contract. if there are only one million shares on issue, please tell me how there can be open short interest of ten million shares.
when the buyer is not delivered stock promptly, it’s called “failure to deliver”. when libertarians start defending willful breach of contract it’s a bit of a worry.
Newson:
You seem to be equating “naked short selling” with “failure to deliver” – 2 different concepts. People contract to deliver things they do not currently own billions of times every day, there is no fraud there.
It is not fraudulent of me to sell the Brooklyn Bridge to somebody, it is only fraudulent if I take the money and do not then deliver ownership.
2 very different concepts.
What? I thought “naked short selling” was:
Someone makes a sale of stock they don’t own and haven’t borrowed for immediate delivery (well, normal settlement, 3 days for stocks).
Then they don’t deliver, but instead provide excuses (it’s arriving from an overseas exchange) and put off delivery.
This is not a future contract and considered strictly there is a failure to deliver.
And it is intentional….
http://en.wikipedia.org/wiki/Naked_short_selling
No, naked short selling is selling a stock you don’t have and haven’t “borrowed” Usually when you go to your brokerage and short a stock the brokerage has that stock available for you to borrow. This is normal shorting. BTW, read the fine print from your brokerage account and you will find that you are allowing them to lend your shares out. At least most brokerage houses do this. So TD ameritrade may have 50,000 shares of GE in custody which you can then “borrow” to short. Of course TDA ensures you have plenty of coverage etc and they also will cover any custodied shares in the event of fraud combined with loss.
Bus naked shorting is selling those same shares but where you don’t even have them available to borrow. Thus you are “creating shares that don’t exist” OK fine but in the end there is a buyer of shares and a seller of shares and a contract between the two. The naked shorter can always defraud but that is different action than not fulfilling the contract. Again, anyone against naked shorting, please to explain futures contracts. Do you think that if every futures contract out there on gold or pork bellies required delivery (almost all are settled in cash), there would actually be enough of the commodity available to deliver? It’s exactly the same deal with stock.
One think I don’t know is how the voting rights of the shares are handled. I’d have to do more research, but if 1 million shares are issues, there can only be 1 million votes.
ds says:
“It is not fraudulent of me to sell the Brooklyn Bridge to somebody, it is only fraudulent if I take the money and do not then deliver ownership.”
not so. given that you know that fulfillment of the bridge sale is impossible, the fraud occurs when the sale occurs, not when the failure to deliver takes place. this is a case of culpable misrepresentation.
to ed:
to enter into a futures contract, you must post an initial margin, and maintenance margin, if the position goes against you.
most futures sales are settled on market prior to delivery, but to participate in the pricing process, real money must be handed over. if short-sales in futures were allowed without margin, and longs had to post them, then there would exist a bias in the pricing mechanism, making the market less reliable for risk-transfer and as well as price-discovery. (think of how the fed’s manipulation affects prices throughout the economy, to realize how inaccurate pricing causes waste).
brokers, by gaming the system, are able to run naked stock shorts for extended and indefinite periods of time, unlike futures which have a definite expiry date.
let’s be clear, naked-shorting is illegal, and it’s only lax policing that has allowed this practice to continue. redress will most likely come via tort actions, though i suspect we’ll see criminal sanctions as well.
there’s a wealth of information on naked-shorts, including mp3 presentations here:
http://financialsense.com/metals/crime/main.html
there’s a ninety-minute animated presentation on naked-shorts (strategic fail-to-delivers) on this site:
http://www.businessjive.com/
well worth the time.
David Spellman is absolutely right. Naked short selling is in no way per definitionem fraud!
@newson
“not so. given that you know that fulfillment of the bridge sale is impossible, the fraud occurs when the sale occurs, not when the failure to deliver takes place. this is a case of culpable misrepresentation.”
Only IF you knew, that becoming the owner of the bridge is impossible for you and therefore you are in no way in the position to sell this as YOUR (potential soon-to-be) property there would be some aspects of fraud.
“Only IF you knew, that becoming the owner of the bridge is impossible for you and therefore you are in no way in the position to sell this as YOUR (potential soon-to-be) property there would be some aspects of fraud.
give me a break! the cliche only makes sense if it’s assumed the deal is impossible.
so i’ll assume you agree that ds’ bridge sale offer is fraudulent.
by extension, deliberately not delivering scrip in satisfaction of a contract within 3 days is fraud, and is punishable under the actual criminal code. whether that occurs is a matter of political will.
“not so. given that you know that fulfillment of the bridge sale is impossible, the fraud occurs when the sale occurs, not when the failure to deliver takes place. this is a case of culpable misrepresentation.”
How do you suppose to prove what I know and don’t know? Intent is a very difficult concept to prove beyond a shadow of a doubt in a legal sensee and the implications of just assuming intent are downright Orwellian.
Again, undelivered shares that were Nakedly Shorted are fraud. Delivery of shares automatically disproves the fraud no matter what you may postulate the intent was. Proof is in the non-delivery, not some abstract and subjective assumption of intent.
to ds:
if you sincerely think you own the brooklyn bridge, you are of unsound mind (therefore the contract is null). if you take money for the brooklyn bridge (as naked sellers do from buyers), and know it’s not yours, it’s fraud. i assume, of course, that you speak in jest.
of course delivery on time fulfils the contract. naked short-sales refers to non-delivery past the three days. proving intent is part and parcel of many a criminal case, so no scary orwellian stuff there.
It would seem from the above statements that the process by which a contract is drawn when naked short selling in not the actual culprit but rather the intentional time lag (the failure to deliver) of the seller that is involved. Not delivering a share when promised is a violation of contract, through which the seller attempts to profit.
Newton:
Thank you for posting that businessjive presentation, it was very informative.
Slide 48 is misleading. It says that the miscreant is issuing phony stock to grandma. Phony stock is not the same as an IOU for real stock and should not be confused. An IOU for real stock becomes phony stock after the settlement date has passed and a FTD has occurred.
My question is: Why does the DTCC propagate the FTD after a settlement date of T+3? What about an FTD at T+300? That’s insane! It would seem that they would be in a perfect position to be sure that FTD’s do not occur by not doing business with shady broker/dealers. This is a truly a settlement / clearing problem. Does the DTCC have any competitors? I guess not since I just found this great (idiotic) article by a DTCC representative outlining why competition in clearing would be a step backward.
http://www.thetradenews.com/asset-classes/equities/2649
Also, when he talks about systemic failure if all the FTD’s would be forced to settle, my jaw dropped. That should alert traders that the DTCC is not doing it’s job or not up to the task in the first place.
Aside:
What if I truly thought that I could buy, and deliver to you, the Brooklyn Bridge from the City of New York?
to jb1122:
t+3 seems pretty well the standard worldwide. that’s the rule here in australia, too.
when t+3 is not met, there’s a breach of contract. sanctions should apply: if it’s deliberate then it’s fraud, if not, then fines or disciplinary action should be applied to maintain the integrity of the system.
businessjive got it wrong about the sec. i think government regulation of securities was a flawed idea in the first place, and the dtcc is a case in point. it would have been better that disgruntled shareholders pursue their claims through tort action, and leave the industry deregulated. competition in the clearing system would be the shareholders’ best ally, i agree.
re: brooklyn bridge – unless there’s some privatization in course, you’d be charged with fraud, i imagine.
your lawyer would presumably plead that your offer was bona fide, but that you’re delusional. you’d probably get off the charge, but you may be ordered to spend time undergoing psychiatric assessment and treatment.
@newson:
You are absolutely wrong in your thinking and in your definition of fraud!
Nobody has to own something at the moment he signs a contract in which he promises to deliver that thing to make a legitimate action. In other words: The non-ownership does not constitute only by itself automatically a fraudulent action.
For example person 1 agrees with person 2 on day D that he is going to deliver P pieces of object O on a certain day X for the price Y.
He does not have to be the owner of these pieces at day D (!). He does only have to fulfill the contract by delivering the promised pieces on day X for the price Y.
Only if person 1 knew that it would be impossible for him to deliver the pieces on day X or if he never intended to deliver those pieces on day X his actions show properties of fraud!
The non-ownership of the pieces P of person 1 on day D is by itself as shown not a sign of fraud!
In newsons defense:
He did say about the Brooklyn Bridge scenario:
“unless there’s some privatization in course”
which is necessarily the case by default if I, as a private citizen, buy the bridge from the city to resell in the first place.
Of course, if the city does not agree to sell it to me, and I had already made a promise to resell, I will breech my contract on the date that I promised to deliver the bridge to the second buyer. In such a case, the deal falls though and I bear the responsibilities set forth in the contract I signed.
The problem for shares is slightly different due to the presence of a settling / clearing company. The shares are supposed to go to the DTCC to get simultaneously settled for cash. However, the DTCC allows (whether purposefully or not) breach of contract to occur in it’s settling process.
Of course, there are all the other transactions that occur outside the DTCC so it’s not fully their fault.
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