The social utility of short selling
John Hempton today lays out the short case for First Solar (and, parenthetically, Palm and Garmin as well), and in doing so says that, in this case at least, I am “not necessarily” harsh in describing such activity as “socially useless”:
If we are right (and we think we are) then we will make money from the demise of a company that has much improved the world. We like to think our business is noble. And it is sometimes – but in this case we can see why people dislike short-sellers. Their opinion however is not our business.
Even with Hempton admitting that there’s precious little social utility to his short position, however, there’s still people willing to defend him as being a force for good in the world. Aristid Breitkreuz, for instance, took to Twitter to defend the short:
Palm’s failure is totally fair. They formerly had a duopoly with Microsoft, both did not innovate at all, and now they are being crushed. Sounds fair to me. Short-selling prevents capital from flowing into these zombies which also helps socially. Capital should flow into the best technology, not the second-best. Or do you want a second-best iPad? Same for First Solar. Bill Gates did not short Kodak because he’s better at running Microsoft. John Hempton is not good at running Microsoft.
This doesn’t really stand up, I don’t think. For one thing, short selling really isn’t very good at preventing capital from flowing into companies. Insofar as it does so at all, it does so by reducing the share price, which at the margin might just make an equity investment look more attractive. And if you want to reduce the share price of a company by selling its stock, you’re going to have much more effect if you’re a long-term investor selling out of your position than if you have no position to begin with and you have to borrow your shares, thereby creating certain future demand for those shares when you have to buy them back.
What’s more, there’s good reason why capital should flow into second-best companies — not least that the best companies, like Apple, don’t need new capital at all. (Fact: Apple’s last stock issuance to outside investors was in 1981.) It’s the smaller, younger companies which need capital in order to compete with the big guys — and competition, as I’m sure Aristid would agree, is a good thing. Yes, I want Palm to come out with a second-best iPad: no good can come of Apple having a complete monopoly on such things.
And while Aristid is right that John Hempton would not be good at running Microsoft, the fact is that he’s smart enough that there is some kind of opportunity cost to his current profession, from a societal perspective. Sure, he could quit his job and become an arms dealer, and that would not make the world a better place. But equally he could quit his job and do something genuinely productive instead, and that would surely benefit society much more than he’s doing right now. In fact, Hempton’s part-time lifeguard gig is clearly better for society than his day job is.
Hempton says in his post that he “will write an article in the future on socially useful short selling”; I look forward to reading it. Here’s one question I hope he’ll answer in that article: is it possible for short selling to be useful insofar as it does not affect the stock price? If I’m a small investor shorting a large and liquid stock, is there any argument that what I’m doing can ever be socially useful? Or in order to be socially useful, does a short seller have to have a certain amount of size and firepower?
But the main reason I’ll be interested to read the article is to see how Hempton squares his argument with the much more common argument that it’s silly to blame short sellers for the collapse of Company X’s share price. It’s not easy to have it both ways — but it’ll definitely be fun to watch John try.