Needlenose

This article in Newsweek in one example of a theme that’s emerged in the last few days – where did the $3 Trillion that was lost on Wall Street go?  These articles have a couple of things in common.  First, they generally follow the theory that you never really had that money, that it was just the market’s perception of the right price at that moment.  True, but unhelpful.  The other thing they insist on is that your money is not, in the words of this article, in the hands of…

The fat cats on Wall Street? Some oil baron in Saudi Arabia? The government of China…

I’ve also heard a few of these discussions on the mainstream nightly news programs, and it’s shocking that these writers and commentators don’t understand that that money actually did go to some of the people mentioned in that article.  That is, If those fat cats, oil barons, and Chinese bureaucrats play “the short end of the market”. 

I’ve found, in my conversations about the market meltdown, that very few folks have much understanding of the long and short of market trading.  Short sales of stocks,the bet that a stock or index will go down,  and ”puts”, their cousins in the options pits,  are often seen as somehow evil , “betting against America”, and have even been blamed for recent market failures,  including some exotic conspiracy theories about the demise of Bear Stearns.

First, where did that $3Trillion go?  A lot of it went to short sellers, and there are a lot more of them, with more convenient ways to go short than ever before.   Previously shorting was a bit more complex than “going long”, or buying with the expectation that a stock will go up.  (For a basic description of the mechanics of short selling, go here.)  There are still millions of individual shares sold short everyday, to traders and institutions.  There are now both general and very focused ETFs (exchange traded funds) that let investors go short either the entire market, specific indices like the Dow or the NASDAQ, or specific sectors, such as financials or technology stocks.  They trade like regular stocks, and some of them are even “ultrashort”, meaning that they use leverage to net investors twice the return from falling markets. QID, for example, the ultrashort NASDAQ ETF, has gone from around $42 a few weeks ago to over $80 today, and trades about 50M shares a day.  That’s where the money went, or at least a good portion of it.

So, the investors who were smart enough to foresee the subprime debacle, or to predict how it would effect the WaMus and Lehmans of the world, have seen a massive transfer of wealth from the pockets of ‘long’ shareholders into their trading accounts.  Rather than thinking of the market as a store of value, in which money that is lost when the market goes down disappears, its more accurate to think of it as a tug-of-war between the longs and the shorts, a minute-by-minute battle that ensures that the price of the instant is the best representation of both the optimism and the pessimism about that stock, the market, and the economy in general.

So, I  don’t buy the idea that shorting is somehow more sinister than the buy-and-hold investing so beloved of  the Suzy Ormands of the world.  Besides lubricating the action of the market, short sellers are often the “canaries in the coalmine”, pointing out, in cases such as WorldCom and Enron, that the emperor has no clothes.  When the SEC recently introduced short sales restriction on certain threatened banks and brokers, many believe they actually damaged the target firms rather than helping them.

So a couple of points…first, it’s a shame that the media is so ignorant of the workings of the market that they can’t explain “where the money went”.  And, in the coming panic, I guarantee that we’ll hear a lot of commentary about the nefarious role of the short-seller, cast as the vulture who feeds on the corpse of our 401(k)s.  And many investors, as they did in the dot-com crash, will follow the market all the way down, following the specious advice of Suzy Ormond and every other hawker of long-only, “buy and hold” strategies. And most folks, including many investors, will continue to misunderstand and vilify the “shorts”, who, if they had only been heeded, could have predicted the current disaster.