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Episode 597: We're Short America
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Episode 597: We're Short America

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Episode 597: We're Short America
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DAVID KESTENBAUM, HOST:

So I had this moment the other day where I realized that basically every penny I own; it's all a bet in one direction. It's all a bet that everything is going to get better. Like, I own a house, right? That is a bet that real estate is going to go up.

ROBERT SMITH, BYLINE: And, you know, it's sort of crazy because you are a guy who is normally pretty cynical about life.

KESTENBAUM: (Laughter) I looked - my entire retirement account, right? - it's, like, stocks and bonds. Stocks are a bet that a company is going to be worth more. A bond is a loan to some municipality that's going to build, like, a sewage treatment facility. It's a bet that that's going to work out, they're going to pay me back.

SMITH: No one would call you Little Mary Sunshine and yet you are doing what everyone else in America does, which is to bet that things are just going to get better. And historically, like, that is not the worst bet in the world.

KESTENBAUM: No, it's a totally fine bet. It just struck me as odd all of a sudden because there is this other bet you can make, right? You can bet in the opposite direction. You can make a bet that will pay off when things go badly.

SMITH: And perhaps you've heard us talk about this before. It is called a short, a short sell. So if you short Apple stock, you're basically betting that Apple stock is going to be worth less in a month or two months or a year.

KESTENBAUM: And if it goes down - everyone else is crying, they're very, very sad - you get to celebrate. Their loss is your gain.

SMITH: And, you know, it's not actually that hard to short something. I mean, you can do it online. Anywhere where you can buy stocks, you can also short stocks. And yet for the most part, nobody does it.

KESTENBAUM: So we decided we would. We would short something. We consulted a bunch of experts. They told us not to do it. They said there are some very, very good reasons people don't short. Hello, and welcome to PLANET MONEY. I'm David Kestenbaum.

SMITH: And I'm Robert Smith. Today on the show, we ignore the advice of some very smart people and we short something. We're going to put our money down on a bet against something that everybody loves.

(MUSIC)

KESTENBAUM: Longtime listeners will know that we have a little bit of money set aside for moments like this. I like to call it the PLANET MONEY investment fund.

SMITH: Also known as the world's least successful hedge fund.

KESTENBAUM: The world's smallest hedge fund. Back in 2010, I think it was, we all put 200 bucks in each, total of $1,000. First, we bought a toxic asset, one of those mortgage things that almost brought down the global economy.

SMITH: Toxi.

KESTENBAUM: We lost half our money on that. Then Jacob and I took what was left and we bought gold. We actually bought a gold coin. We lost some more money. That was like three years ago. I put whatever we had left in a locked cabinet here and we basically forgot about it until last week.

KESTENBAUM: Robert?

SMITH: Yes, sir.

KESTENBAUM: You want to see how much money we have left in the PLANET MONEY investment fund?

SMITH: Oh, yeah, totally. Wait, where is it?

KESTENBAUM: It's in the locker here.

SMITH: (Laughter) I'm surprised it's under lock and key.

(LOCKER OPENING)

KESTENBAUM: I think this is the key.

SMITH: (Laughter).

KESTENBAUM: It's in the jar here.

SMITH: It's in a jar?

KESTENBAUM: Yeah.

(LOCKER CLOSING)

SMITH: (Laughter). What is there, like, $6 in there?

(COINS RUSTLING)

SMITH: Come on.

KESTENBAUM: And a note. I have a confession. A couple years ago, I needed cash. I didn't have time to go to an ATM, so I got the money out of the jar. I did put a little note there, but looking at it today, like, I don't know exactly what I meant by the note. There are two numbers there, one is crossed out. I'm pretty sure we have $406.06 left in the fund.

SMITH: You are the worst. I can't believe this. All right, man. PLANET MONEY jar is back in effect.

(COINS RUSTLING)

SMITH: Put the lid on. And this is it. Let's see if we can - let's see if we can make it all back.

KESTENBAUM: There's no way we're making it all back.

SMITH: (Laughter) It is theoretically possible. And the reason why we wanted to pick shorting is really we have done podcasts on shorting before and economists are always talking about this as this important part of the financial markets. That it help stocks from becoming too hyped. It keeps bubbles from forming.

KESTENBAUM: But I really had no idea how it really worked. I certainly didn't know, like, what we should short or how to do it. So we went to consult an expert - one of the experts. This guy's name is Andrew Left. He used to write a newsletter. The title was Stock Lemon, though, he changed the title.

ANDREW LEFT: Well, Stock Lemon was very tongue-in-cheek. I thought I just needed more of a highbrow name.

SMITH: The new name? - I love it - Citron Research.

KESTENBAUM: Andrew's been at this for over a decade. He's the guy that when CNBC needs to get a short seller on, they often grab him.

SMITH: And he's great on the air because he's betting against things that other people love. You know those little cameras that if you go skiing, you see everyone has these little cameras on top of their helmet?

KESTENBAUM: GoPro? Yeah.

SMITH: He short GoPro. He short Tesla, another company a lot of people love.

KESTENBAUM: And Green Mountain Coffee.

SMITH: Yeah, those little tiny K-Cups that's you put in the...

KESTENBAUM: Oh, that's what those are.

SMITH: Yeah, yeah, yeah, exactly.

KESTENBAUM: So we asked his advice. Suppose someone with almost no investment experience and very little money came up to you and said I want to try to short a stock.

LEFT: No, don't do it.

KESTENBAUM: Why?

LEFT: It's not - it's a very skilled form of investing. It really is not for the average investor. It's dangerous. You could lose too much money doing it. The forces of Wall Street are against you. It's not worth it. Do something else.

KESTENBAUM: You know, when we went into this, I sort of thought that shorting a stock was just the opposite of buying a stock. You know, instead of betting that a stock is going to go up, you're just betting that it's going to go down. But as we dug into it, I realized it is not. It is a completely different animal in just about every way.

SMITH: Yeah, there's all these hurdles you have to go through, I think, both mentally and financially before you can short a stock. I mean, the first one is the most basic thing, which is - OK, most stocks seem to go up over time. You have to find a company that is different. You have to find a company where you know something that no one else knows. You have to find a company that you hope will plunge in value.

KESTENBAUM: You got to find something like this guy found.

SAHM ADRANGI: My name is Sahm Adrangi. I'm the chief investment officer of Kerrisdale Capital.

SMITH: Sahm is another famous short seller. He is 33 years old, and for a 33-year-old, he has a very large coin jar. His hedge fund has over a quarter billion dollars under management.

KESTENBAUM: His offices were a few blocks away. We went over to talk to him - very un-fancy. Sahm sat down in this little conference room and he coached us on how to pick a stock to bet against. He told us this one perfect little story, a best-case scenario about this one company that he had found to short.

SMITH: This is back in 2010, and Sahm is poking around, looking at certain Chinese companies. Chinese companies were just starting to be listed on U.S. stock exchanges. And he found this one company that had a business model like Princeton Review. They basically coached Chinese students on how to pass entrance exams for college.

KESTENBAUM: The company was called China Education Alliance. It was offering these classes and selling these sample tests online. And Sahm looked at the website. It looked OK to him, but he couldn't read Chinese. So he got a guy who could read Chinese to actually try it out, and he found something weird.

ADRANGI: And what he came back with was - can't - couldn't actually purchase any products. Despite the fact that this business generated half of its sales from selling, testing out website, its website was completely nonfunctional.

SMITH: Wait, they couldn't, like, order anything or put in a credit card?

ADRANGI: Yes, so when you tried to go to the part of the website where you would put in your credit card, an error screen popped up.

SMITH: Very, very suspicious. But, you know, the company did say that it taught classes in person. So he decided to check on that too.

KESTENBAUM: So this was harder to check because the building where the classes were taught were in this northern province of China near the border with Russia. But Sahm found a guy to go check it out. Like, he found a freelancer through one of these websites where people say I'll do odd jobs. Sahm paid the guy $1,000, which he was very excited about, and asked him to go check out the building.

ADRANGI: And we asked him to take a camera. So he went there and saw that it was a completely vacant building. When you went to each of the floors - there are six floors - there were no chairs, there were no chalkboards. It was just a completely vacant building.

SMITH: So think about this for a moment. There is a company that everyone loves, that everyone thinks is doing this gangbusters business and Sahm knows something unique. He knows that this company isn't doing anything. Sahm thinks it's a fraud.

KESTENBAUM: A perfect stock to short. Now, Sahm warned us. He said, like, if you find something you think is like this, you have to be really careful. You have to do your research because what's about to happen next can be a total roller coaster, though the actual act of shorting a stock turns out to be very simple.

ADRANGI: It's just a matter of pressing the red button instead of the green button on your account so...

KESTENBAUM: Was it really just a button - a red button you press?

ADRANGI: It is a red button, yeah. I think it was - or it might say short.

KESTENBAUM: Do you remember how it felt pressing that button?

ADRANGI: You know, slightly dangerous (laughter).

KESTENBAUM: If you're a normal investor and you buy a stock, you can just sit back and wait for the company to succeed, right? They have a PR team out there. The company itself is trying to make the case that it's going to be great. But if you short a company, you got to go out there and make the case that it's overvalued. Sahm had bet against China Education Alliance, but he was only going to make money if the stock price dropped. So he shouted it to the world. He posted a video of the empty building online. And he and his team wrote this really detailed report that they put out there basically saying the company was a fraud.

ADRANGI: I think we released around 10 a.m. on November 30, 2010. And within two hours, the stock had declined 50 percent.

SMITH: He ended up making a bunch of money. And we asked Sahm, you know, how did it feel? And he was, like, good. Like, no, seriously, like, were you dancing? Did you pop champagne? I mean, you had just brought down a company and made a fortune. And he's like no, no, not really.

KESTENBAUM: We asked it like 10 different times. And I think, basically, he's a pretty even-keeled kind of guy. But I also think there's this other going on, which is really another way in which shorting is totally different from normal investing. Your profit is really everyone else's loss. There were lots of other people who had invested in this company hoping the stock price was going to go up. And now, thanks to Sahm, it had collapsed. I get that it felt weird to celebrate.

ADRANGI: Yeah, it's a bit bad of form. I mean, I think there's a lot of investors that, you know, become blindsided when we put out these reports. And these guys don't like us for losing the money. We'll say, you know, you were investing in a company that was committing fraud and so you should be blaming the management instead of us, but most guys blame us.

SMITH: There are so many reasons not to become a short seller. I mean, we have to be ready to be hated by everyone, David. We have to have some sort of special, secret knowledge that we're 100 percent sure of.

KESTENBAUM: You're leaving out the best thing. This is a very practical point that Andrew Left made.

LEFT: You can lose an infinite amount of money - infinite.

SMITH: I feel like we should just pause on that - infinite. This is probably the major reason that people don't short because - let's just say that you are an optimist, that you're buying stock in a company that you hope will go up and it goes down, right? What's the most you could lose if you buy $100 worth of stock? You could lose $100. But if you short sell, it is completely different.

KESTENBAUM: When you short a stock, what you're actually doing is - here, I'll spell it out. You borrow the stock, then you sell it in the hopes that you can buy it back at a lower price and return it. Got it? (Laughter) So I know Jacob hates it when we do this but let's demonstrate.

SMITH: We got to do it.

KESTENBAUM: I think it's going to actually help. Robert, you have an actual stock.

SMITH: Yeah, and until I got this in the mail, I didn't know that they still made...

KESTENBAUM: ...What is it?

SMITH: ...Paper stocks anymore. This is a paper stock certificate for a small community bank in Pennsylvania. It is a gift to my daughters from their grandmother. In theory, I suppose, to pay for part of their education.

KESTENBAUM: All right. So say I, for whatever reason, want to short this lovely little bank. Here's how it would work. First, I need to borrow a share from someone who has one.

SMITH: I got one.

KESTENBAUM: Thank you. I have to give it back to you at some point.

SMITH: Oh, yeah. It's for my kids.

KESTENBAUM: All right. So I take this borrowed stock and I sell it. So say the price right now is 10 bucks a share. I pocket that 10 bucks. Now I got to give you a share of the bank stock back at some point.

SMITH: Damn straight.

KESTENBAUM: So I wait. Hopefully the stock price drops. Then - great - I can buy one back cheap - hopefully for, like, you know, pennies. Then I return the stock to you and we're done. I made a profit - almost 10 bucks.

SMITH: So that's the rosy scenario for you. Now the - as Andrew Left put it - the infinite amount of money scenario.

KESTENBAUM: Starts the same way - OK, let me borrow the stock, right? I sell it for 10 bucks and I wait. But this time instead of the stock price dropping, let's say, it goes up. And, let's say, it goes way up, like, the bank has an incredible year. Some big investor comes in, wants it to expand and, say, the stock price goes up to, like, 50 bucks.

SMITH: Now you are screwed, David Kestenbaum, because you owe me that stock and you have to buy that stock and it's at $50. You have lost a ton of money. Or supposed the stock went up tenfold, now you got to spend $100 to buy that stock to return it to me - or $200 or $500 or $1,000. In theory, there is no limit to how much you can lose.

LEFT: You could lose an infinite amount of money - infinite.

SMITH: And how much is in the jar?

KESTENBAUM: Four-hundred and six dollars and six cents. That's less than infinite.

SMITH: All right, David. Let's go down the checklist of things that we need to short a stock. Number one - a stock we think will go down.

KESTENBAUM: No check, we don't have that.

SMITH: Big pile of money.

KESTENBAUM: Don't have that.

SMITH: And number three, number three - we heard about this from several people - we need a lawyer.

KESTENBAUM: Andrew Left told us that he had been sued four times. And he told about this one episode where a CEO got really, really, really mad at him. And his wife noticed this black truck parked across the street.

LEFT: And she went out and they said does Andrew Left live here? And she said yes. And they made a comment - we're friends of - and they said the CEO's name.

SMITH: They just sat out there, outside Andrew's house in that black truck.

LEFT: I called the CEO right there on the phone. I'm like what do you think you're doing? This is Wall Street. This is business. Like, what world do you live in? What do you think - like, what world do you live in?

KESTENBAUM: What did the guy say after you said that to him on the phone?

LEFT: Typical thuggery type stuff - you don't know who I am. Like, what does that mean? I know who you are. You're the CEO of a publicly traded company, like - (laughter) - just nonsense.

SMITH: You know, David, this is exactly the kind of drama I was worried about when we started this project because I'm a journalist, you're a journalist, kind of in our DNA is to be neutral. And the premise of this project is that we are going to bet against a company. We're going to put our money on the line saying that some company is going to fail.

KESTENBAUM: And then we're going to talk about it on the radio and the podcast.

SMITH: This is probably against the NPR ethics guidelines, I'm sure.

KESTENBAUM: I mean, we knew this was a problem from the start. So we spent a while in the office here talking about this. And we came up with a solution that I was actually really excited about. Instead of shorting a particular company, we would short every company. We short the entire stock market.

SMITH: Which is not as complicated as it sounds. There's a way to do this.

KESTENBAUM: You know how there are index funds which include like a tiny piece of lots and lots of stocks? You can buy those. Turns out, you can also short them. You can bet that the entire stock market is going to go down.

SMITH: As we went back and forth about this, we realized that this is a perfect short because we weren't picking on some tiny, little company where some CEO is going to call us up and try and bully us. We were picking on the biggest economic target there is in the entire world. The plan would be for PLANET MONEY to short America.

KESTENBAUM: We ran the idea by Sahm.

ADRANGI: Yeah, that's a terrible idea. It's very dangerous and it's a great way to lose lots of money. Basically, you know, the stock market is a reflection of the aggregate profits of all of the nation's public companies. And every year, companies make more and more profits, especially American companies because, you know, I think 40 percent of their revenue comes from outside of the U.S. So you're essentially shorting global corporate profits. And as long as populations are growing and there's innovation, companies are going to make more money year in year out.

KESTENBAUM: I'm shorting the whole planet.

ADRANGI: Yeah, that's why it usually doesn't work.

KESTENBAUM: Sahm did have a name for what we we're proposing. He called it the Armageddon Trade, which sealed it for me. We definitely had to do it.

SMITH: Yeah, I think he was trying to talk us out of it. But Armageddon Trade was perfect 'cause you can picture some broker somewhere saying everything great and powerful that has ever existed in the world eventually goes away; Ottoman Empire - gone, Roman Empire - destroyed, dinosaurs - disappeared.

KESTENBAUM: Dinosaurs were before the others.

(LAUGHTER)

SMITH: Go with me on this. No one thought that they would fail and they did. America can't last forever.

KESTENBAUM: Sahm was not persuaded by the dinosaur argument. I ran the idea also by Andrew Left and he was actually OK with the trade. He said the stock market could go down. If you time this right, you guys could make some money. But he was not OK with the term shorting America. He really didn't like it.

LEFT: Do we have problems? - of course. We have a lot of moving parts. But as for shorting America, I just don't - I don't like the way that sounds. We are hands down the greatest country in the world to invest in. We really have done an amazing thing in this country.

KESTENBAUM: It's nice to hear a pep talk from a guy who specializes in shorting.

LEFT: Yeah, listen. That's what part of - the amazing part about this country is the ability to short. I mean, how great is that that we live in a country that says you know what? You can buy a stock. You don't like the stock? You can short the stock.

KESTENBAUM: And that's what we did.

(SOUNDBITE OF PHONE RINGING)

STEPHEN PEARSON: E-TRADE, elite client services. This is Stephen Pearson.

KESTENBAUM: I did it through an E-TRADE account. Because shorting can potentially cost you so much, I had to stick extra money in. Not an infinite amount, but 2000 bucks of my own money into the account just as a buffer. Then we were ready to go. I want to short something.

PEARSON: All right.

KESTENBAUM: I want to short the entire stock market.

PEARSON: The entire stock market? Well...

KESTENBAUM: Stephen said I'm not sure we can short the entire stock market, but we can come close. He said there's this thing that tracks the S&P 500. It has a little slice of the 500 largest stocks. Great, I said, let's short that. A minute later, it was done.

PEARSON: All right. I've got that trade placed for you.

SMITH: America, your bad news is now our good news.

KESTENBAUM: In fact, by the end of the call, the stock market had gone down. We made a little money.

SMITH: How much?

KESTENBAUM: Eighty cents - it's a start.

(SOUNDBITE OF SONG, "WILD")

ROYAL TEETH: (Singing) Don't you think it's time for you and me to make some history. Tell me now...

KESTENBAUM: On the next podcast, we're going to have the story of what, as far as we can tell, was the very first short ever. It was a surprisingly long time ago and it does not work out well for the guy trying to do it. Let's just say, it gets a mention on his gravestone.

SMITH: It's not easy being a short these days. If you are bullish on the U.S. Stock Market, you want to tell us we're insane, please write us - planetmoney.org or you can follow us Twitter @planetmoney. And every day we will tweet out how much money we have made or lost on this particular short. The hashtag? #sorryAmerica.

KESTENBAUM: Also we really recommend checking out NPR's latest show, Invisibilia. It's all about the invisible forces that shape our behavior. Actually started thinking for the first time - after I heard the last episode - about what it was really like to be inside someone else's head.

SMITH: You can subscribe to Invisibilia on iTunes, Stitcher or however you listen to podcasts. Our producer today is Jess Jiang. I'm Robert Smith.

KESTENBAUM: I'm David Kestenbaum. Thanks for listening.

(SOUNDBITE OF SONG, "WILD")

ROYAL TEETH: (Singing) Help me see everything we used to be. We won't forget the lives we've lived the loves we've chased. We lost the things we can't replace. We were young and wild. I believe that I can make you scream...

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