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Okay, FK and others, put this into plain English that even a 5th grader can understand. What does this mean?

Update 4: Merkel to formally announce naked short-selling ban on Wednesday.

Update 3: Hearing naked ban will also apply to credit derivatives, i.e. naked CDS.

Update 2: Bloomberg chimes in quoting Deutsche Presse which reports that the ban will only apply to naked shorting. We are looking for official confirmation on what the final proposal will look like as there is a lot of confusion currently and no formal announcement. Regardless, investors are wondering what has changed today to institute this now.

Update: short selling ban will apply to stocks and euro government bonds according to German N-TV station. This is an act of desperation and will force all those who are long German assets to sell asap (selling is still legal).
2,583 Posts
Its not supposed to happen in the U.S. either as far as I know.
Do we need to ban it again? Kind of like making it illegal to be in the country illegally??

"Naked shorting" is selling shares that you don't already own... without first barrowing them from others who actually own the shares.

Shorting sounds screwy to most people but look at it this way: its the opposite of buy now sell later. Shorting provides liquidity and is probably a net positive to the market. Naked shorting creates shares that do not exist. I have held a stock that was more than 100% owned by institutions. That was because of naked shorting.
The price of silver has been held down by JP Morgan's naked short selling of silver.

15,924 Posts
Shorting was so bad a year or so ago here in the US that I recall the SEC banned short sales on many (dozens?) of stocks. Here's a discussion:

I don't see how shorting of any sort -- naked or otherwise -- helps the market. It creates a perverse incentive in which the investor hopes for a company to decline and profits from it doing so. In some ways, it's contrary to what is best about a market system. A parasitic arrangement.

3,112 Posts
Short selling is a financial strategy by which you can borrow shares, sell them, and profit (hopefully) from buying them back at a lower price and returning them to the group you borrowed them from. A very simplified example:

I want to bet that Bank of America is going down in price.
I call up my account at Goldman and execute a trade by which I borrow BAC shares from the Goldman proprietary account.
I then sell those shares in the open market.
That whole transaction takes place when BAC is priced at $10 in the market.
BAC drops in price two weeks later to $5.
I buy BAC shares in the open market at $5 and give them back to Goldman.
I profit $5 on every share I did that with (that is the spread of $10 borrowed - $5 returned).

Now, that is short selling.

Naked short selling occurs when I do everything that I did above, but WITHOUT actually borrowing the stock. So I do not take possession of those borrowed shares. There are costs associated with borrowing those shares so when you do not take possession of them, you avoid those costs and, quite literally, have sold something that you did not own.

Now, the question is, why is that bad.

Well, if you can move the market, you can see really quickly why this could be bad. If you allow huge funds that move many billions, to naked short a stock, then you have allowed them to all of a sudden create tremendous supply in a stock (by selling it) which can hammer the price (supply and demand 101). When you do this without taking possession of the stock that you just sold, you create a situation where that stock may not even be "borrow-able", meaning that your broker that you are trying to borrow the shares from, may not own enough of them to "settle" the trade.

If I want to short sell 10 shares of GE, I have to borrow 10 shares first from my broker. The trade literally cannot settle (start or finish) until I borrow those shares. If the broker does not have 10 shares, he must first go get them and remove them by buying them (back to supply and demand). So this action always keeps the true number of shares accounted for.

BUT..... if you allow naked short selling then it is possible (and it happens all the time) for you to create an out of whack supply/demand of the stock. If you are not forced to take possession of the stock then you are truly selling shares that do not exist.

You have created a supply of that stock that was not first removed from the system by being purchased.

10 shares of GE exist in the entire system.

I want to short 5 of them.

My broker has 0 shares.

I naked short 5 shares meaning I do not take possession of those 5 shares but sell 5 shares into the market.

There are now 15 shares of GE (10 original, and 5 I just made up and sold) which increased the total number of shares (float) by 50%!!! Furthermore those shares were sold which means that 33% (5 of the 15 shares) were sold, you can imagine what that kind of supply "shock" does to the price of a stock. It hammers it.

Talk about a rigged game.

3,112 Posts
Here is the problem though, if the ban extends at all to short selling, then what you do is restrict the flow of information and price discovery.

Notice in my example that I must BUY the stock back and then return it to the broker for me to close out the trade. That action of buying the stock puts a bid under the stock, it creates demand for that stock and that demand is what you hear when you hear that people are "covering their shorts". They are buying back those stocks. You will often see in a down market these little blips up of buying, it is usually short covering, or people buying back those shares.

It is not true demand, but short covering will stop out of control down markets. They put a floor in the markets.

This is why those stocks on the short sale ban list underperform other stocks.

15,924 Posts
Probably shorting should be banned in general. If the market can't bring together competition, investors, and build better widgets and move forward, then it serves little purpose.

In my area, bricks & mortar antiques, collectibles, etc. there is no such thing as shorting. We buy what we feel is under-valued, and price discovery occurs only when we sell something at more than what we purchased it for. This encourages and represents real growth in demand for something. It encourages wise purchasing, positive speculation (not dis-speculation), etc.

If you have a mechanism in which there are incentives to misrepresent the value of something 1-2 times, and then settle on the lower value, it creates too many perverse incentives. It doesn't build things, a better mousetrap, etc. It encourages anti-company management and investors to pump & dump.

Basically, the stock market is like a coast of ports for pirates to plunder.

The Power of III
1,365 Posts
Germany is apparently pulling no punches in stopping a bunch of stuff - found this on Market Ticker this evening and understand it thanks to FK's nice explanation previously ^^^^:



If you thought the German government was going to be a lapdog for Sarcozy, or worse, was going to fellate Brussels and the ECB, you got a rude shock today.

It appears that the German Government has just plain had enough of the crap that the banksters have tried to pull, and has decided to do what Barack Obama should have done in early 2009.

That is:

* No more naked credit crap, especially against sovereigns but not only against sovereigns. No insurable interest, no CDS - period.

* Naked shorting will now be actually stopped in 10 leading financial institutions.

* Germany has had it with naked shorting of Gold, and specifically noted bank manipulation of gold prices via naked shorts beyond intent or ability to deliver.

* Germany has also said that they're not going to permit Euro derivatives that are not a "bonafide" FX hedge. That is, no more naked bets on Euro movements either.

* Hedge funds are going to be regulated, position size limits mandated and enforced, reporting enhanced and a transaction tax is coming.

It's about damn time.

Oh, and it appears that instead of telling all the banksters what they were going to do and "getting permission" first, or even discussing it with other governments, the German Government did what all governments should do - make up your mind and then do it without giving a good damn whether the banksters or other governments like it - and without giving them input into the decision or notice that it's coming.

The bid rigging, the game-playing and the rest are all a bunch of crap. I've been hollering about this now for more than three years and yet our government spends it's time fellating the bankers and their dogs instead of enforcing the law.

It is illegal to defraud people.

It is illegal to rig markets, including the massive bid-rigging that I wrote about this morning, the Jefferson County Alabama scam and dozens if not hundreds more - all committed, it is alleged (and in some cases proved) by the major banks.

It is illegal to short stocks with no intention or ability to deliver.

And it is illegal to bribe government officials, no matter how you accomplish it.

These are not "isolated incidents" or even a pattern of conduct - as the bid-rigging report this morning makes clear ripping people off has become an institutionalized practice and policy throughout the entire banking system.

Many said that the Germans were not "really" arm-twisted by Sarcozy and the French Banking interests a week or so back. I think we can put that to rest here and now, as it's pretty clear that the truth is something else entirely.

Now Barack, about your willingness to get up off your knees and kick these banksters in the nuts?

Better late than never.
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