The Stock Exchange from Within. William C. Van Antwerp
by the time they have got into the soothing columns of the Hughes Commission’s report, they will be ready for new points of view.
As a preparatory lesson: suppose a speculator buys from a commission merchant a carload of coal of a specified grade. The coal is not in the possession of the commission merchant, but he knows where he can get it, and he knows that he can deliver it on the date agreed upon. Accordingly he sells it short, and enters into a binding contract which, happily, the courts construe to be perfectly legal. Now suppose the same purchaser wishes to buy 100 shares of Pennsylvania Railroad stock. All Pennsylvania stock is the same, that is to say any 100 shares of it is just as good as any other 100 shares of the same property—the number on the certificate is of no importance whatever.
The dealer to whom he applies does not happen to have 100 Pennsylvania on hand, but he knows where he can get it, and he knows that he can deliver it to the purchaser on the following day. So he sells it short, and all that remains to complete his part of the contract is the actual delivery. He is then a bear on Pennsylvania stock. He may, if he chooses, go into the open market and buy the stock at once, so that he will be able to deliver it in the easiest and most direct way. Or he may feel that by waiting he may be able to buy at a lower price than that at which he has sold it, hence, in order to make the delivery promptly, he borrows the hundred shares from one of his colleagues, to whom he pays the market price as security for the temporary loan of the certificate.34 In a day or two the price of the stock may have declined, whereupon the bear goes into the market and buys the 100 shares of Pennsylvania at a price, say, 1 per cent. lower than that at which he sold it.
When this certificate is delivered to him next day, he delivers it in turn to the man from whom he borrowed the original 100 shares; his security money is then returned to him, and the transaction is closed. It is just as real a transaction as any other, and just as legal. Moreover, since it is always possible to buy, but not always possible to sell, the active presence in the market of large numbers of bears who must buy, whether they want to or not, is the very best policy of insurance that a holder of securities could have.
Many years ago there was a law on the French Statute books, subsequently repealed, prohibiting short sales. M. Boscary de Villeplaine, a deputy chairman of the association of stockbrokers, was conversing with Napoleon regarding a pending discussion in the Council of State looking to the repeal of the law. “Your Majesty,” said de Villeplaine, “when my water carrier is at the door, would he be guilty of selling property he did not own if he sold me two casks of water instead of only one, which he has?” “Certainly not,” replied Napoleon, “because he is always sure of finding in the river what he lacks.” “Well, your Majesty, there is on the Bourse a river of Rentes.”35
Napoleon felt, no doubt, that there was something inherently wrong in selling short; even as these lines are written, counsel for a Congressional committee is attempting to make witnesses admit that the practice is “immoral.” But why, where, how is it immoral? It pervades all business; no question of morals or ethics enters into it at all. The man who sells you a motor-car has not got it; he accepts your money and enters into an agreement to deliver the car next spring because he knows or believes that he can make it and have it ready for delivery at that time. Meanwhile he has sold short. A gentleman of my acquaintance has sold thousands of storage-batteries on the same basis, although plans for them have not yet been designed to meet the specifications. At Cape Cod the cranberry-growers sell their crop before it has begun to mature; all over the land contractors and builders are “going short” of the labor and materials which, at some time in the future, they hope to obtain to fulfil the terms of their agreements. Are all these worthy people “immoral”?
If it is immoral to sell for a purpose, it is equally immoral to buy for a purpose; in each case the purpose is the hope of a profit. Buying for a profit is approved by every one; why not selling? In both instances you have bought or sold for a difference in price; the sequence of the events in no way involves a question of morals, since there is no ethical difference and no economic difference between buying first and selling last, and selling first and buying last. Moreover, in selling short you do no injury, since you sell to a buyer, at his price, only what he wants and is willing to pay for.36
All suggestions of impropriety in short selling are grotesque in their absurdity. But suppose, for purposes of argument, that economic errors of some sort were actually involved in this practice. How could it be regulated or controlled? As the governors of the Stock Exchange stated to the Hughes Commission in 1909, short selling is of different descriptions. There is the short sale where the security is held in another country and sold to arrive pending transportation. There is the short sale where an individual sells against securities which he expects to have later, but which are not in deliverable form; and in this connection I call your attention to the recent sale of $50,000,000 of Corporate Stock of the City of New York where deliveries were not made for a period of about three months, and which stock was dealt in enormously, long before it was issued.
“If a market had not been provided for it under those conditions,” said the governors, “the loan could not have been placed. Then, again, there is the short selling of stock against which different and new securities are to be issued; the vendor knowing that he is to receive certain securities at a distant date, but desiring to realize upon them at this time. Beyond this, there is the regular selling of short stock, either by parties who do so to hedge a dangerous position upon the long side of the market, or the sale purely and simply with the intention of rebuying at a profit, should circumstances favor it.”
Finally, there is the investor with stock in his strong-box actually paid for and owned outright. He may wish to sell in a strong market with the hope of repurchasing at lower prices, but for reasons of his own he may borrow the stock for delivery rather than deliver the securities bearing his own name. Technically he is short; he is a bear. But in his case, as in that of the others here cited, how can this perfectly proper method of doing business be “regulated” or interfered with in any way? I do not think it necessary to pursue so palpable an absurdity.
It has been said that the bears often resort to unfair methods to bring about declines in prices, circulating rumors designed to alarm timid owners of securities and thus frighten them into selling. That this is done every now and then is undeniable, but the opportunity of the bear in these matters is very limited, and may be easily and speedily investigated, whereas similar practices, by the bulls in inflating values by all sorts of grotesque assertions and promises are by no means so easily run to earth, and do incalculably more harm.
The bear who drags a red-herring across the trail now and then interrupts the chase, but he cannot stop it; the genial optimist who has a doubtful concern on his hands, with a pack of enthusiastic buyers in full cry at his heels, is a much more serious matter. Good times and bull markets engender many questionable practices of this sort. “All people are most credulous when they are most happy,” says Walter Bagehot; “and when much money has just been made, when some people are really making it, when most people think they are making it, there is a happy opportunity for ingenious mendacity. Almost everything will be believed for a little while, and long before discovery the worst and most adroit deceivers are geographically or legally beyond the reach of punishment. But the harm they have done diffuses harm, for it weakens credit still further.”37
If this book were written for people instructed in economic matters there would be no occasion to dilate upon the usefulness of bears and the value of short selling, but since we are addressing laymen who do not understand how the bear can be a useful factor, we may venture to say once more that insurance is the chief advantage in his operations. Ex-Governor White’s contribution to the subject, which I have quoted in this chapter, is strongly supported by Mr. Conant, who shows that valuable progress in opening new countries and developing new industries is often made possible by “bearish” operations designed to “hedge” or insure the new undertaking against loss.
“The broker who has a new security which he desires to place from time to time in the future, making possible, for instance, the opening of a new country to railway traffic, protects himself against loss resulting from future changes in market conditions by selling other securities for future delivery at current prices. These securities will realize a profit when the date arrives for delivery if the market