Reuters Edge

Short sellers have been the villain for 400 years

NEW YORK (Reuters) - In 1609, a merchant contracted to sell shares in the Dutch East India Company in the future, sending the company’s share price into a plunge. A year later, the authorities imposed the world’s first ban on short selling.

If that sounds familiar, it has some parallels to today’s market, where regulators around the world have introduced curbs or outright bans on short selling to protect companies from people who bet that the share price will go down.

Short sellers, or “shorts,” have been blamed for almost every financial crisis in the 400 years since the Dutch episode.

Shorts came under fire after the U.S. stock market crash of 1929, and U.S. President Herbert Hoover condemned short selling in 1932.

More recently, shorts were blamed for the U.S. stock market crash of October 1987 and, in 1997, Malaysia charged Credit Lyonnais with short selling after the collapse of the country’s currency and stock market.

The next year, the New York Fed bailed out Long Term Capital Management to avoid wider market impact from the hedge fund’s short positions.

“We’ve been the natural scapegoats for decades,” said David Tice, manager of the Prudent Bear Fund and an influential short seller.

Even in good times, short sellers are disdained for betting against the continuing party.

But the short sellers say they are only raising flags that stocks are overvalued.

“We are the ones that warned about credit excesses and how much danger there was and tried to warn regulators and institutional investors,” Tice said.

Short sellers borrow shares from a broker and sell them in the market in anticipation that the price will fall. They then buy the shares back at the lower price, returning them to the broker, and profiting on the price decline.

The tactic can be used as a hedge against traditional investing or an aggressive play against a stock perceived to be overpriced, known as speculative short selling.

In either case, the perception is that short sellers benefit from the misfortune of others.

This time around, short sellers say they did not create the housing bubble that led to the crisis hitting investment banks. They just discovered its consequences.

“I feel like we are the good guys, but when the media attention is on us and the president and the treasury secretary are talking about it is kind of a lonely vocation,” Tice said.

The U.S. Securities and Exchange Commission (SEC) imposed an emergency ban on short selling on Thursday. Similar restrictions came from Britain, Australia, Canada, Germany, Taiwan, Portugal and Ireland.

When U.S. financial stocks fell on Monday, experts said the shorts may have skirted the restrictions by using put options -- the option to sell a stock in the future at an agreed price -- or by shorting the entire index and buying the companies it did not expect to fall.

“I don’t think it (short-selling) is malicious. It’s people acting in their self interest which is what Wall Street does,” said Martin Sklar, an attorney representing hedge funds, which typically engage in short selling.

In the current crisis, Morgan Stanley MS.N CEO John Mack blamed short sellers for driving his firm's share price last week. Others blame the shorts for the collapse of Lehman Brothers LEHMQ.PK, contributing to it filing for bankruptcy.

The shorts say it’s all about the balance sheet. The financials were overleveraged and overvalued.

“There is no academic evidence that short sellers by themselves brought a company down without other underlying reasons,” said Paul Asquith, a professor of finance at MIT’s Sloan School who specializes in the study of short selling.

“Lehman was having problems and the shorts were there. But once Lehman started looking for a buyer, what happened? Nobody wanted to buy Lehman when they started looking at their books very closely. That tells you the shorts were right.”