Following on from a previous post, I want to quickly look at how the Bible addresses the ethics of short selling for investment purposes. What is the Christian response to short selling? Amidst all the commentary on the credit crunch, I'm yet to read a thought-through biblical discussion of the subject. Hopefully this will raise some fruitful questions...
Stewardship – ordering creation for the glory of God
The Bible doesn’t talk explicitly about short-selling, and there are few analogies for borrowing and selling what you do not own! Generally investment and the deployment of capital (of whatever kind) would come under the wider priority of stewardship – mankind is tasked by God to “work and take care of” creation (Gen 2v15), to order the world around us such that - by our efforts – God is glorified. It is clear from the parable of the talents and elsewhere that the reference point for assessing the success of this work of stewardship is the return of Christ.
Without wanting to press the individual statements of the parable too hard, the concept of “reaping what you did not sow” is clearly viewed negatively. Within stewardship there would seem to be a connection between "sowing" (i.e. the productive deployment of capital whether relational, financial, labour,…) and the reaping of it’s fruits (i.e. investment returns of whatever kind).
Is short-selling stewardship?
I want to suggest that short-selling is effectively “selling other investors a dummy”. Other market participants who would otherwise deploy productive risk-bearing capital unwittingly have that capital diverted into simply risk-bearing capital (without the accompanying productivity).
What goes on if I short sell shares in a company? Let’s trace it through...:
- Short-seller borrows 10% of ShoeCo from Investor A (who is a long term investor in the company. They have intentionally deployed their capital for the production of high quality shoes that will be a blessing to their wearers, provide a valuable outlet for the skills and giftings of leather workers and designers,…).
- Our short-seller sells the borrowed shares “short” to Investor B (who wants to buy the shares in order to deploy their capital into ShoeCo for the same reason).
What has really happened?
Investors across the market now think they own 110% of ShoeCo (we might think of investors A and B both owning "the same" 10%). That is only possibly because Short seller economically owns “minus 10%” and has created a corresponding synthetic long position in the market.
Effectively, our short-seller has replicated the economic risks and rewards of deploying risk-bearing capital productively into ShoeCo, but without any of the accompanying productive benefits (more shoes being made, talents being put to work,…).
Investors have been sold a dummy! Instead of deploying productive, risk-bearing capital, some of them merely think they have! They are arguably “reaping what they did not sow” (because there has been no sowing thanks to the facilitating actions of the short-seller). Capital has been diverted away from being productively put to work. (The two parties might just as well be spread-betting on the football, except the information they are acting on is financial/commercial rather than sport-based).
To make the point, let’s (simplistically) think about what would have happened if the short-seller hadn’t been a market participant:
Alternative 1:
Suppose investor A isn’t willing to sell to Investor B at a price they both like (let’s ignore other market participants to make life easier). Investor B has capital to deploy, and (let’s say) he likes Shoes…
- Maybe he buys shares in SneakerCo (thereby releasing an existing investor in SneakerCo to deploy their capital productively elsewhere).
- Maybe Investor B likes the supply chain that includes ShoeCo and so (unable to invest in ShoeCo at the right price) he buys shares in LeatherCo instead (ShoeCo’s main supplier).
- Maybe Investor B puts his capital to risk productively by investing in a shoe start-up with a talented young entrepreneur.
Whichever the outcome, Investor B’s capital is deployed in a way that is both risk-bearing and productive. There is some “sowing” of capital going on.
Alternative 2:
Investors A and B are able to agree on a price for 10% of ShoeCo’s shares. Investor A takes the proceeds and puts them to work in much the same way as Investor B in the previous alternative.
Without the presence of the short-seller, whatever the outcome, capital is deployed in a way that is both risk-bearing and productive. Man’s God-given mandate to fill and subdue, work and take care of creation is being furthered.
So the diverting of risk-bearing capital away from fulfilling the creation mandate would seem to be the Biblical grounds for objecting to short-selling. (I put my hand-up and recognise this a crude first pass at the question!).
Is short-selling facilitating stewardship?
Advocates of a free-market economy may argue that short-sellers grease the wheels. They help make the market more efficient by increasing liquidity, and enabling the views of more market participants to be reflected in the market price. Having the ability to short-sell allows an investor who sees a share as over-priced to actively express that view and thereby depress the price (by increasing supply of the shares). Otherwise, the same investor is obliged to sit on the side lines, and assume financial risk in some other way (hopefully productively).
To put that defence, it seems to me you would need to be able to show that:
- short-selling activity results in a more effective allocation of risk-bearing and productive capital than would otherwise be the case. (That may be true)
And
- that the benefits of heightened efficiency more than outweigh the “phantom capital” created in the economy by “selling dummies” to other potential investors. (I think that’s probably a tough case to make).
So on that basis, I would raise questions about naked short selling. Not because is bank-robbery. Not because the people who do it are necessarily immoral (although those who combine short-selling with rumour-mongering may act that way - see my previous post). In isolation, short-selling is a distraction from the creation mandate. It does not serve to bless, order or create.
(Aside:
I’m talking here purely about outright short positions.
I think it’s possible to put an argument that option-based hedging is OK (to the extent that general limited liability investment in shares and insurance are both OK). I would make that case because productive economic risk taking is being passed between market participants in a zero-sum game (i.e. there is no outcome where synthetic capital is being created and capital is put to work without being economically productive).
I think on this basis relative value trading is a grey area – you could put a case for it being a re-allocation of capital within the system (from the shorted asset to the long asset)… But it doesn't feel like a great case. Something to think more about…)
