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Short Sellers' Impact On Markets

Nov 9, 2018
Originally published on November 9, 2018 11:42 am
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STEVE INSKEEP, HOST:

In recent weeks, the S&P 500 lost most of its gains for the year. If you have retirement money in stocks, that's probably not good. But one group of people can be happy - short sellers, people who bet against the market. They're the most hated people on Wall Street. But they may provide a service. Here's Darius Rafieyan and Cardiff Garcia from Planet Money's The Indicator podcast.

CARDIFF GARCIA, BYLINE: A short seller is someone who bets against a company, who makes money if a company's stock goes down. And it's really easy to write off short sellers as, like, vultures who swoop in to feed on the carcasses of dead or dying companies. But it's a little bit more complicated than that. Xiaoxia Lou is a professor of finance at the University of Delaware. And a few years ago, she was seeing a lot of stories in the news about short sellers.

XIAOXIA LOU: You read about these high-profile battles between short sellers and the companies they target.

DARIUS RAFIEYAN, BYLINE: There was this hypothesis that they actually could be very good for markets because they uncover bad behavior. And she wanted to test that hypothesis in a systematic way. So she and her colleagues looked at all of the companies that had been disciplined by the Securities and Exchange Commission for cooking their books, for financial misrepresentation.

GARCIA: What she found was that in the year and a half before the financial fraud was revealed, there would be a huge spike in short selling on that company. And not only that, but the worse the fraud, the more shorting there was. And the fraud tended to be exposed earlier when short sellers were involved.

LOU: There's evidence showing that short sellers actually act like detectives, and they're making money, but in the meantime, they actually provide important benefits to the financial markets.

RAFIEYAN: Short sellers actually end up being better at identifying fraudulent behavior than just about anyone else in the market.

ANDREW LEFT: Well, you know, short sellers are financially motivated. So whenever people are financially motivated, they're going to do a better job.

RAFIEYAN: Andrew Left is a professional short seller. And to hear him tell it, he's sort of a Wall Street vigilante.

LEFT: I enjoy exposing bad guys when I see guys I think are doing, you know, bad things to the market or to investors.

RAFIEYAN: Andrew first got the idea to short companies back in the 1990s.

LEFT: Out of college, I worked for a boiler room. I answered an ad in the newspaper.

GARCIA: What these boiler room firms would basically do is they would use lies and they would use fraud to pump up these crummy stocks. Andrew decided he just could not do it anymore, so he quit.

LEFT: Someone just said to me, hey, why don't we just short those companies?

RAFIEYAN: Andrew knew that the stocks being pushed by these boiler rooms were BS because he'd been on the inside.

GARCIA: Exactly. If these boiler room firms were saying these stocks were great, he knew they were terrible. So he thought he'd make a profit off that.

RAFIEYAN: So Andrew built a very lucrative business by revealing information about companies. And the thing about markets is they work better when there's more information available because that means that the price of a stock will more accurately reflect whether or not it's actually a good company. And Xiaoxia Lou from the University of Delaware says short sellers can be very helpful in that regard.

LOU: For the market to be efficient, we need all sorts of players so that all this information could be incorporated into stock price. So short sellers play a very large important role, in my opinion, for market efficiency.

RAFIEYAN: Someone like Andrew Left, he may seem really odious to us because he profits off of other people's failure, and that feels kind of icky. But the data suggests that these short sellers are helping to keep companies honest. Darius Rafieyan.

GARCIA: Cardiff Garcia, NPR News. Transcript provided by NPR, Copyright NPR.