Finance Fridays With Mary, Volume 2: Short Selling : Planet Money Short sellers are investors who bet against companies. They're the detectives of the stock market, unearthing flaws and making markets more efficient, though they also attract controversy.
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Finance Fridays With Mary, Volume 2: Short Selling

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Finance Fridays With Mary, Volume 2: Short Selling

Finance Fridays With Mary, Volume 2: Short Selling

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  • <iframe src="https://www.npr.org/player/embed/749998579/750005175" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript

CARDIFF GARCIA, HOST:

Do you know why there is a bell here?

MARY CHILDS: No. No, why is there a bell here?

(SOUNDBITE OF BELL)

GARCIA: That is the jargon bell. It's an idea that we borrowed from our friends at the Financial Times. Every time you use a piece of jargon, I'm going to ring this bell, and then you have to explain what that bit of jargon actually means, in plain English, like you were explaining it to your Uncle Dabo (ph). OK, let's get started.

(SOUNDBITE OF MUSIC)

GARCIA: Hey, everyone. This is THE INDICATOR FROM PLANET MONEY. I'm Cardiff Garcia. And this is the second installment of Finance Fridays with Mary, where my friend Mary Childs, a finance reporter at Barron's, answers your questions about the world of finance, about Wall Street, about banking and hedge funds and all those kinds of things. Mary, welcome back.

CHILDS: Thanks for having me.

GARCIA: Today on the show, Mary, you're going to cover short selling.

CHILDS: Heck yeah.

GARCIA: Right? - betting against companies, rather than for.

CHILDS: The most American thing you can do.

GARCIA: Yeah. No, it's not. It's not (laughter). But it still matters. It's important, and we're going to explain why right after the break.

(SOUNDBITE OF MUSIC)

GARCIA: Mary, ready to field this question about short selling?

CHILDS: Super ready.

GARCIA: The question comes from listener Boris (ph) via tweet. We're going to have our producer Rachel Cohn read it in her distinctly non-Boris voice.

RACHEL COHN, BYLINE: How does shorting work? What is the mechanism for investing against something?

GARCIA: OK, so Mary, normally, when I think about putting money into the stock market, I think of buying a stock and then hoping it goes up. Short selling is betting against the company and hoping that its stock goes down. Why does anybody do that?

CHILDS: So I think short selling becomes useful when you think the market's missing something. You think that the bank analysts are too optimistic, which happens. You think that everyone is reading the numbers wrong. The company has fudged something in their numbers on their balance sheet. And when you see that and no one else has caught on, you have a huge opportunity to profit.

GARCIA: By the stock going down?

CHILDS: That's right.

GARCIA: OK, and so this is an instance, in very basic terms, in which you think that a company just isn't performing well enough to justify its stock price.

CHILDS: It's trading at a hundred, but that's only because everybody doesn't know something terrible about the company, and it should really be at 20.

GARCIA: OK, it should be at 20 or...

CHILDS: That would be, like, a really good one.

(LAUGHTER)

GARCIA: That would be, like, an amazing short.

CHILDS: You should do that right now.

GARCIA: Right.

CHILDS: Yeah.

GARCIA: Yeah. OK, so why is it important for the market - OK? - for the buying and selling of stocks and securities, why is it important that short sellers are a part of it?

CHILDS: You need short sellers to be able to come to the true value of a company, the true price of a company. The natural bent is, oh, my gosh, a company. I love it. Let's do this. I want a share in this company. It's probably going to grow. Companies do great things. Let's have a stake in that. That's the natural bent.

So having the ability to bet against, having this ability to express a contrarian view, means that people are going to work harder. If no one was going to bet against the company, the company can do whatever. So having short sellers around and having people able to express this negative view is saying, hey, I looked at your books, and actually, you messed up, or hey, I think you're hiding something. And that means that there's more what they call price discovery.

GARCIA: OK. Yeah, just a soft little ring of the bell there.

(SOUNDBITE OF BELL)

GARCIA: Price discovery - so that prices accurately reflect how well a company is doing...

CHILDS: Yeah.

GARCIA: ...How well it's positioned in the marketplace. So in terms of how people actually bet against companies, how does short selling actually work? - which, of course, is the question that we were asked by Boris.

CHILDS: Boris, are you ready for this? So we...

(LAUGHTER)

GARCIA: Here come the mechanics, all right.

CHILDS: We have a stock right here that I drew on some paper.

GARCIA: OK.

CHILDS: It's a stock here. And we're going to demonstrate to you, even though you can't see us, what happens. So basically I'm a bank. I have this stock. I'm holding it.

GARCIA: Right.

CHILDS: And Cardiff wants to bet against it.

GARCIA: I'm the short seller. You're the bank.

CHILDS: That's right.

GARCIA: OK.

CHILDS: So Cardiff thinks that this company of which I have this stock...

GARCIA: Let's call it Apple. Let's say I think Apple's going to go down, right?

CHILDS: It's a fruit company.

(LAUGHTER)

CHILDS: So Cardiff says, I need to borrow that stock.

GARCIA: Right.

CHILDS: I lend this stock to Cardiff. Here, I'm handing it to him.

GARCIA: OK, I've got it in my hand. So I now have this stock, but I have to give it back to you later. I have only borrowed this stock.

CHILDS: Right.

GARCIA: Right?

CHILDS: It's on loan.

GARCIA: OK, so if I understand this correctly, the next thing I'm going to do is sell this stock into the marketplace, where - let's say - our producer Rachel Cohn...

COHN: Hello.

GARCIA: ...Is buying stock. So...

CHILDS: Notorious trader, Rachel.

GARCIA: Yeah, exactly. OK, so Rachel, I've got this stock of Apple that I've borrowed, OK? I'm selling it to you now for $100, OK?

COHN: Excellent. Thank you, Cardiff.

GARCIA: Yeah, you got it. OK.

CHILDS: It's a good-looking stock.

GARCIA: Now, let's say I wait, I don't know, two weeks, and the stock price has fallen.

CHILDS: Apple had terrible news.

GARCIA: Yes.

CHILDS: All of the apples went rotten.

GARCIA: Exactly. So now this stock is only worth $80. Rachel...

CHILDS: So sorry, Rachel.

GARCIA: ...You're sad about this, all right? But I'm going to buy this stock back from you for $80.

CHILDS: No.

GARCIA: I know. Remember - I sold it originally for $100, OK? And I bought it back for $80, which means I now have $20, and I've got Apple stock, OK? I have to give Apple stock back to you, Mary, the bank.

CHILDS: Thank you, please.

GARCIA: Here you go. So my debt to you is paid off, and I have $20 of profit.

CHILDS: Nailed it.

GARCIA: Nice.

CHILDS: You're very good at this. You should hedge fund.

COHN: (Laughter).

GARCIA: I should do this.

CHILDS: I know.

GARCIA: Yeah, it seems so easy, you know. In practice, though, it's not easy. Quick follow-up question here - why would you, as the bank, lend me that stock in the first place?

CHILDS: Securities lending is a great business. If I have this, like, stock sitting here, just, like, hanging out - it's not doing me any good - but I can lend it out, and you'll pay me.

GARCIA: So I'm paying, like, a fee to borrow that stock in the first place?

CHILDS: Correct. And I love money because I'm a bank, so give me that money.

GARCIA: I know. You're the worst.

CHILDS: I know (laughter).

GARCIA: Let's talk about some real-world examples because, from what I understand, things can get pretty heated. You got a bunch of people who are betting that a stock is going to go up, and now here come the short sellers saying it's going to go down and trying to find reasons and publicize those reasons for why the stock should go down. There can be some confrontations here, right?

CHILDS: Absolutely. This can get very emotional. This seems to be the main way in which people express their emotions in finance, I feel like, where you have one hedge fund manager who, like, really believes in the company...

(LAUGHTER)

CHILDS: ...And then one other hedge fund manager who thinks it's a zero. And that's a big difference of opinion, and there's a lot of money on the line, so they freak out.

GARCIA: What's your favorite example of two hedge fund managers who are like, yes, I love the stock on the one side, and the other is like, no, this stock sucks, and now we're going to argue about why I'm right and you're wrong?

CHILDS: I'm glad you brought this up. There is one benchmark, gold standard example of this. Once upon a time, there was this hedge fund manager named Bill Ackman, and he got a bee in his bonnet. He really hated this company Herbalife. He thought that it was a total scam - all this stuff. And he was very public about this, as shorts often are, because they're, like, you know, shaking people, being like, you have to see how this company is a zero. And one hedge fund manager on the opposite side from Ackman was this guy Carl Icahn, who's a notorious corporate raider from the 1980s.

(SOUNDBITE OF BELL)

CHILDS: Oh.

GARCIA: Sorry - corporate raider, yeah.

CHILDS: In the '80s, he was a huge deal.

GARCIA: Buys companies and then strips them and sells them, right?

CHILDS: Messes with them real hard.

GARCIA: Yeah, OK. Right.

CHILDS: So Carl Icahn is a bruiser. Like, he loves a good fight. And he sort of picked one with Bill Ackman over Herbalife. This culminated in this moment where Bill Ackman and Carl Icahn, like, argued on CNBC about this stock. Just like...

GARCIA: Just in the middle of the day, right?

CHILDS: Just shrieking at each other. And, I mean, every - like, trading floors around the world just, like, stopped and were like, oh, my God, what is happening? - and just watched because it was just like an actual playground brawl.

(SOUNDBITE OF ARCHIVED RECORDING)

CARL ICAHN: I've really sort of had it with this guy, Ackman. He's like the crybaby in the schoolyard. Ackman is a liar, OK?

BILL ACKMAN: Carl Icahn unfortunately does not have a good reputation. He's a bully, OK? Carl, I have no interest. You think I want to invest with you? OK, let's move on. Let's move on.

ICAHN: I wouldn't invest with you if you were the last man on Earth.

ACKMAN: Let's move on.

CHILDS: It's rarely this dramatic, to be honest. This was, like, just a beautiful episode. But yes, this does come around with some regularity because there's always a company doing something shady, or there's always a person hoping that a company's stock will go to zero.

GARCIA: There is also, I think, the worry that short sellers might not just try to honestly uncover what's wrong with a company - in other words, what a company actually is doing wrong - but that they might spread false rumors about the company to try to drive the price down. And then they profit from it, even though actually the company was doing fine.

CHILDS: Right. There's this idea that short selling - because you can make enough noise, especially if you're kind of one of these big-name people - if you have a track record, just the fact that you are short a company will move the market. And so then you can take your profit, and you can just zoop (ph) that right out of the market and go on your merry way, if people say, oh, I trust that person; they definitely did their homework, or if you happened to have somehow inserted inaccurate information into the market. So there can be - there's room for nefarious activity here.

GARCIA: OK. Mary Childs, thanks for being here.

CHILDS: Thanks for having me.

GARCIA: Remind everyone again where they can find your work.

CHILDS: Barrons.com.

GARCIA: Barrons.com. And your email address?

CHILDS: Mary.childs@barrons.com.

GARCIA: There you go. Send Mary your questions for future installments of Finance Fridays with Mary. This episode of THE INDICATOR was produced by Rachel Cohn, fact-checked by Emily Lang and edited by Paddy Hirsch. THE INDICATOR is a production of NPR.

(SOUNDBITE OF BELL)

CHILDS: Is that - did I do it right?

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