Wednesday, May 19, 2010

Financial ... naked short selling ... part of a bigger problem

Dear Colleagues

A few people have made a lot of money speculating on the capital markets ... including currency markets. George Soros has been doing it for a very long time, sometimes on a large scale with spectacular results. So have others!

On a more modest basis, I made a considerable amount of profit for my company (Continental Seafoods) one year when I was its CFO by selling currency futures. Though this made profit for the company ... I was in trouble! Lawyers ... not accountants, thought it was the equivalent of a naked short sell. In my view, it was a hedge because I was going to have a foreign currency French Franc cash flow from future sales of our product in France, and it was better to do the conversion to US dollars sooner rather than later because it was pretty clear that the Franc was going to devalue and substantially. Though the "deal" was made in minutes ... I had been researching currency exchange rates in detail daily for more than two years ... so this move had not been taken lightly.

Markets are a key part of a well functioning economic system ... and within a market it makes sense to have a lot of flexibility. There are times when it makes sense to sell short, and in moderation, this stabilizes the market. But bankers and others in the financial community are not "into moderation" ... rather, they operate on the basis that this works and makes profit, so why not do more and more of it as fast as possible ... now at super computer speed, and instead of this flexibility being a source of stability it becomes instead a source of massive instability.

A couple of weeks back there was the case of the free fall in the New York markets ... a few minutes of total panic and some well known companies traded for pennies. As far as I know, the exact cause of this meltdown is not clear, but the systemic problem is that a big part of the market is no more a market of reality but a cyber speed computerized digital model with virtual everything. Reality does not seem to enter into the transaction process at all ... and risk of mayhem ever present.

I applaud the German move to ban naked short selling ... taken without much consultation with the people that run markets, and therefore giving little opportunity for these people to water down the ban so that it is effectively nothing. A lot of other practices should probably be banned as well since they are merely devices for manufacturing profit out of activity that has no economic substance.

I am pro-market ... but the market I believe in is one where the result is to get the allocation of resources to activities that are both profitable and valuable. This is possible ... but it will never happen when the dialog is all about profit and nothing about value. Bloomberg News is amazing technology ... but the 24/7 dialog, chatter and news feeds from all over the world, never ever has anything about value. No wonder that resources flow into things that are profitable, whether or not there is any social value.

Changing to a value based dialog is not easy ... but it is vital ... and it needs to be done sooner rather than later. The banking and financial sector meltdown was caused in part by profit devoid of value. But this issue of profit versus value is not over yet by a long shot. The fact of some 15 million people unemployed in the USA is a terrible indictment of the market system as it is presently operating ... and the terrible governmental imbalances whether it is the US Federal Government, or many of the State Government in the USA ... or Greece, Portugal and Spain in the Euro Zone ... or Britain ... or Iceland. There is a lot of discontent ... the Red Shirts in Thailand ... and a lot of reason for discontent. The market system ought to be doing a better job ... including being of help facilitating the progress of 4 billion people on the planet from deep poverty to something better ... including upgrading important infrastructure ... including improving global governance ... and it can do a lot when the metrics being used are not only about profit but also about important values.

Naked short selling ... a problem ... but only a tiny part of a massive and powerful market system that ought to be doing a lot more good, and will do amazing things as soon as the metrics are more aligned with the CA methodology!

Peter Burgess

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