It’s the revenge of naked capitalism on the Street.
A new study that examined NYSE and Nasdaq stock movements over a 42-month period says naked short selling, when not abused, serves a valuable purpose.
The study’s findings fly in the face of claims by Lehman Bros.’ Dick Fuld and Bear Stearns’ Jimmy Cayne that naked short sellers took their companies down, and bring into question the validity of the Securities and Exchange Commission’s decision at the height of the 2008 crisis to ban most of the practice.
In a naked short, the trade, almost always done by a market maker for itself or for a large client, involves selling stock that it does not own and is not borrowing from someone else. Here it owes the shorted shares to the buyer, but “fails to deliver.”
There’s no evidence these back-office stock delivery “failures” by traders caused the crash of Lehman and the other big names, according to the study, conducted by Vikas Raman of Warwick Business School in the UK, Veljko Fotak of the University of Buffalo and the University of Oklahoma’s Pradeep Yadav and published by the Journal of Financial Economics.
Spikes in the number of fails came after Lehman and other firms announced they had hit an iceberg, the authors noted. These fails were blamed in part for Lehman’s destruction.
“While we do not advocate tolerance for fails to deliver (FTD) tied to manipulative episodes, we find no evidence indicating that FTDs, in aggregate, systematically and manipulatively precipitated price declines, even in the extreme situation of the 2008 financial crisis,” Raman told The Post.
A surge in FTDs actually led to a reduction in pricing errors, intraday volatility, spreads and order imbalances, the study said.
“The ability to fail arguably reduces stock-borrowing costs at the time when such costs are at the highest,” Raman added.
Short sellers emerge more as folk heroes than cowboy capitalists in the study, which exhaustively examined 1,492 NYSE and 2,381 Nasdaq stock movements from January 2005 to June 2008. Yet naked short sellers, long regarded as bad boys, have been squeezed.
“By all means, let’s crack down on abuses of naked shorting, but the practice itself is not an abuse,” said Dr. Edward Swanson of Texas A&M University, in the wake of an earlier study on this topic.
The study puts pressure on regulators to loosen their post-crisis grip preventing the practice.
“This is great news. There is nothing better than a free and open market,” one professional trader gushed to The Post. “Limiting people from short selling only creates zombie companies and doesn’t allow for new and nimble companies to enter the market.”