The Art of the (Short) Sale


I recently watched the movie The Big Short over the weekend, so when I saw this prompt is on ethics, this idea quickly popped into my mind. For those who may not be familiar, the movie is based on the same-named book by Michael Lewis (author of Money Ball, Liar’s Poker, Flash Boys) about a few groups of people who recognized the housing bubble of the early and mid 2000’s and decided to short sell the entire housing market. Essentially what they were doing was betting the housing market would crash and then they would in turn make money, rather than lose it. The technical side of how the trade actually works is not as important as the externalities of short selling and the idea. This (short selling, or shorting) can be done on just about any commodity, market, bond, company, etc. so it really made me think about how this technique fits into the ethics of the business world. Short selling is hoping companies, or markets do poorly or, in the “best case”, fail entirely, and I use quotes there because the best case in short selling is not always the best case for the world. So, short selling must be ethically wrong in almost every case, or, at least to me it would seem that way.

Now, I am not entirely familiar with the concept and technical pieces that move around on a short sale trade, but some information from The Business Ethics of Short Selling and Naked Short Selling from the Journal of Business Ethics gives a quick rundown on what short selling does to the economy. It promotes liquidity in the market, keeps trading prices in align with cash equity markets, and reduces overvaluation in the market by introducing negative information. These are some benefits to short selling being allowed in trading platforms around the world, but there are, of course, negatives. From the same journal, short selling incentivizes unethical activity, short sellers profit off of other’s misery, and sometimes cause it, short selling can be considered gambling not trading, and also increase market volatility among other effects.

I think this topic is so stimulating because on first look, the idea of the short sale is a complete ethical, and moral, mess. Take consequentialism for example. In short, consequentialism implicitly says, “the ends justify the means”. But for whom? In the case of the short sale making a lot of money, at the expense of other people’s jobs and livelihoods, it is ethically correct for the individual, but maybe not if we are looking at the business world and personal lives of everyone else involved. This also brings up the point that just because someone short sells something in the world, does not mean they caused it, or encouraged it to happen. The traders could simply seek to profit off a problem that was already created and not recognized by the systems in power, as seen in the movie The Big Short. Still from a moral standpoint it is hard to know all those profits and checks are coming at the expense of regular people, who’s company or industry may have failed and they are left scrambling to recover their lives. From a deontological view, the opposite of consequentialism ethics is true, that is the ends do not justify the means. If someone were to hope, and perhaps influence a company or industry to fail or lose value as they shorted it, the trader would be unethical. But what if they did not hope or influence the failure of a company or industry and still shorted said company or industry? Are they ethical by deontology’s views simply because the rules of the game allow short sales? In many markets around the world (the U.K., Australia, China) short selling had been or still is banned or severely regulated for at least some portion of its history. The rules of one country state short selling is wrong, bad, illegal etc. so can the idea that it is allowed in another country (the U.S.) make it unethical by a deontologist, no matter what the circumstances are? The rules allow it here, but not somewhere else. Can ethical theories be relative to location? I suppose they can if they involve the rules and laws, such as deontology, but that just creates more gray areas, or so I would think. I feel I could go on and on about this topic for a while, but I think you get the idea here; short selling is an ethical mess.

There are of course arguments for the benefits of short selling. It can be a good price discovery mechanism, short selling is an indiciator of poor future stock performance, and short sellers act as a secondary ‘watch dog’ in some cases by exploiting market mistakes in a company’s fundamental values. By these measures it would appear to be ethically good for the economy. Without short sales there is a larger opportunity for both fraud and misleading price information being shown to the traders and consumers. Would a virtue ethics based viewer rather higher price inflation, or the potential of making profit off of other’s misery? Fraud (loosely used here) or unemployment? There seems to be two sides to every argument, and that is why act utilitarianism appears to be the “great equalizer”. It takes the facts only and weighs them against each other in a fair matter. May the greater side win. This could be beneficial for many business transactions as it is, as I like to think, a pros and cons view to every decision. Of course some cons could be “heavier” than some of the pros it is up against, but we can save that argument for another time. Looking at every decision in a purely factual and rational view point can serve everyone well.

I’m inclined to believe the short sale is some sort of financial necessary evil, to keep prices and inflation in check. A world of optimists is not ideal for the financial world, just look at the film The Big Short and examples of blind optimism are shown. Some one needs to be the cynicist, or even realist in times like the 2008 financial crisis. Of course profiting off of people’s job loss and industry failures is morally terrible, but is it ethically wrong as well? That remains up for debate.

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Pictured above is a simple 2-step graph describing the actual transaction going on behind a short sale.

Featured Image: The Lehman Brothers were one of the major financial firms severely affected by the 2008 crisis. They were declined a buyout and government bail out and were forced to file for the largest bankruptcy protection case in history. Thousands of Lehman Brothers employees were left without jobs. Some (lucky?) few were left with millions and millions of profits because of short sales.

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6 thoughts on “The Art of the (Short) Sale

  1. An ethical mess is about the only way to describe short selling. I too saw The Big Short a couple weekends ago and it left my mind bending in ethical ways I never knew possible. In my opinion shorting a company is simply taking advantage of other peoples mistakes. This is ethically sound and is simply capitalizing on the system. There are strong arguments on both sides of the ethical line here and it is something that many professionals still discuss today.

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    1. I find it interesting you see shorting as simply taking advantage of others mistakes. Many times it’s a single or small group of individuals that are responsible for a company’s failure so many of the people left jobless had no idea or no interaction in the fallout. There’s a quote from The Big Short that says “every 1% unemployment goes up, 40,000 people die.” Does that make it any more complicated? (I don’t want to take the quote as 100% true but I’m sure there’s a statistic somewhere to back it up to en extent.)

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  2. I like your ethical analysis of short selling, particularly how you note the different conclusions reached by various theories. Short selling definitely poses an ethical dilemma, as it does involve the capitalization on others’ misfortune, but I do not believe that it is always entirely unethical. For example, would short selling Enron stock have been unethical, even if it was done with the intent of exposing and ending fraudulent and illegal business practices?Also, the guys in The Big Short tried to expose the issues they had discovered with the housing market, but nobody would listen.

    Still, I believe that short selling is damaging because it allows one individual or one investor to have a tremendous amount of power. Consider, for example. George Soros, who is infamously known for selling short 10 billion dollars worth of British pounds, forcing Britain to remove itself from the European Exchange Rate Mechanism (ERM) and leading to the collapse of the British economy on “Black Wednesday.” Soros is said to have profited 1 billion dollars alone form this single trade. Clearly, cases like this show that short selling provides one individual an inequitable amount of power and influence. Were Soros’ actions unethical? Probably. But illegal? No.

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  3. I think that Brady brings up a good point about short selling and the investor actively trying to have a company or currency fail. I think that large activist investors can largely affect the stock price in a negative way, but they can also increase the value. When well known hedge funds or investors purchase a stock, it shows that they believe that it is worth something, or undervalued. The issue is that this can sometimes inflate the price to extreme levels. This gives the large investor a huge profit. The thing with short selling is that it is considered negative because it can lead to the collapse of a company while increasing the value, only leads to false prosperity and profit.

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  4. Ben and I had a deep conversation about this in person whilst making some gourmet food. I want to play devil’s advocate JFF and look at this topic from a utilitarian perspective. Simply put, if a company’s stock price is going down for any number of reasons, isn’t it better to have some people making money to balance out or even create a net positive depending on the investment vehicle? JFF

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  5. Short selling as price discovery is a world apart from driving a stock down to short sell through releasing false information or trying to get others to sell in quantities to create a short-term panic.

    It is the difference between physician-assisted suicide for a terminally ill patient on one hand (ethical) and “pre-emptive third-party coerced suicide” which the Mafia might call a long swim with the fishies.

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