The whole naked shorts thing was incited by Patrick Byrne, CEO of Overtstock.com and a certifiable lunatic who basically believes that he has the right to a high share price. It doesn't help that the cable news media's coverage of this has been so bad. They keep saying that "shorting" is okay but "naked shorting" where the stock isn't delivered isn't.

Well what about a naked long position? If you own any stock out there, try to get the certificates delivered to you, just try. If your brokerage even allows such a thing (it probably doesn't) it will take weeks. We don't pass around and deliver shares anymore, this is 2008. We just attach names to the shares that are out there.

This is really just another chapter in the age old war on the shorts. At one point people tried to argue that shorting American companies was unpatriotic. Now, even when the cable news people point out that it's entirely legal they present shorts as villains who profit off the misery of others.

There's a difference between ordinary shorting and "naked" shorting. In ordinary shorting, the person (or broker, really) doing the shorting finds a willing lender of the stock, and borrows the stock from that lender. The shorter then sells the borrowed stock. Meanwhile he (the shorter) owes any dividends to the lender, and at any point, the lender may demand that the shorter replace the borrowed stock.

This is how it actually worked in the old days with paper certificates: Joe S (the short) borrowed the stock from Bob L (the long), sold it to Fred, and paid Bob the dividends. Bob knew that his stock was loaned-and-sold, and that the company's records showed someone else (Fred, in this case) as the owner, so Bob could no longer vote his shares.

With a "naked" short, though, Bob doesn't bother finding a Joe first. He just prints up a fake certificate and sells it. This is (and has always been) illegal, and with paper certificates, it amounts to counterfeiting and Bob tends to get caught and imprisoned.

What has happened today, though, is that the paper shares have disappeared. We now have electronic shares, cleared through the DTCC: the Depository Trust Clearing Corporation. Sellers sell and buyers buy (through brokers as usual), and the DTCC clears most of the trades in the end, doing electronic bookkeeping. This works fine when used legitimately.

Sometimes, however, sellers sell and buyers buy, and the DTCC waits a few days, and finds that the seller has "failed to deliver" (FTD). These FTDs are the problem. Now, occasionally something goes wrong, and there is a regular Failure To Deliver that is nothing special. These are relatively rare. To handle them, the DTCC creates "placeholder" shares, so that the buyer sees shares in his brokerage account, even though the seller failed to deliver any.

The problem today is that the number of FTDs has grown enormously. No one can tell exactly why. The DTCC might be able to tell, but they are not saying. The SEC implemented RegSHO to keep track of persistent FTDs. The number of FTDs, and the length of time the sold stocks have not been delivered, has gotten entirely out of hand.

We have at least one actual instance of someone buying every single share of a penny stock, getting them all delivered in paper form (one can do this by writing to the company, especially after one has bought the entire set of outstanding shares), and putting them away in a safe place ... only to see shares trade on electronic exchanges. We have many instances of more votes being cast at corporate shareholder meetings than there are shares. So clearly there are counterfeit electronic shares in the system somewhere. Which ones are real, and which ones are counterfeit? How do we tell?

Naked Short Selling. Does this make sense?

I'm a hedge fund in the Cayman Islands (boo!). I call up Goldman Sachs and tell them to place a short sale of 10,000,000 shares of XYZ (or Freddie or Fannie a couple of weeks ago). Goldman says they can't process the sale, because they don't have that amount of shares in their accounts ("in street name").

I tell GS, "Go ahead and sell. I've located those shares and will be borrowing them from that party. I'll be able to deliver them to you within the time allowed. But don't even ask me where I'm getting them."

GS doesn't ask. I'm a good customer and they expect to make a lot of money on my future transactions. Before the required delivery date I cover the short so the delivery issue is moot.

My question: Will GS ever make me prove I could have delivered what I promised?

How is this any different than gambling in Atlantic City - except that these corporations are the "bedrocks of the economy" and "there would have been systemic risk if they had not been saved' ie bailed-out? Who is supposed to be keeping track (regulating), or are they self-regulating? What happened to free-markets?

Come on, this ios a good first step. The better next step is bring back the uptick rule. I have to agree with wild river review blog http://www.wildriverreview.com/wrratlarge/ that the ease of short selling without uptick rule allows the bullys in the market to pile on.

Shorts are a symptom of the disease, not the disease itself. Short sellers only target sick corporations or they risk losing their shirts. This precipitates their collapse, but the real culprits/frauds are the corporate fat cats who over-leveraged or engaged in high risk, even illegal behavior.

These corporations are already bankrupt or nearly there through years of unbelievable corruption. Shorts shorten the period of pain and bring them to their deserved end.

I am still waiting for anyone to tell me why the evildoers pushing a stock price down by shorts are any worse than the evildoers who push a stock price up through speculation.

Try a little logic here folks. Joe average investor sees junk.com priced at $100 a share and decides to buy in. Because Junk.com is really only worth $1 a share, but was just driven up to $100 by the evildoers' speculation, Joe average investor loses his shirt as the price plummets to $1 a share.

Who is policing the market to make sure that Joe average investor isn't killed by evildoers in this way? Why is it worse for Joe average investor to be hurt by shorts (which may reflect the fundamentals) then to be hurt by evildoers who pushed the stock price up through speculation before he bought.

The harm is the same in either case (the price of the shares he owns fall) and if there is a moral distinction, no one here has yet pointed it out.

In fact, if short sellers are trading based on fundamentals they are doing us all a public service. Again, why does anyone want over-valued stock prices.

Let's get rid of the superstitions on short-selling.

Dean:

In theory, at least, the speculators who bid a stock up have to pony up actual money (or actually borrowed money) to buy the stock they're bidding up. Shorts don't, at least not for the length of the delivery window. So there is at least a little difference.

Here it seems (although you can argue with the policy) that the idea is to reduce the number of stupid extraneous things going on while the bailout rules get worked out. The fed really doesn't want to see if it can stay solvent (for some approximation of that term) longer than the markets can stay unsettled. If the short ban is still on after that, then we go from possibly-wrong to nefarious.

Precisely. It's temporary. My reading gives me the impression of a "better safe than sorry on presuming some really bad actors, we've got too big of a mess right now" move.

I found the following article in today's NYT print edition helpful in that regard. The article has already been buried on the website by new reports from the same reporters, but it has some helpful history from the last few days:

A Bid to Curb Profit Gambit as Banks Fall
By VIKAS BAJAJ and JONATHAN D. GLATER
http://www.nytimes.com/2008/09/19/business/19backlash.html?ref=todayspaper
A backlash against short sellers has begun, with regulators in the U.S. and Britain tightening rules and authorities in New York intensifying investigations.

Especially note the quote from Andrew Cuomo (NY Atty. Gen.), info. on the HBOs (mortgage lender) failure in Britain, and, at the end of the article, reports from New York State’s and New York City's comptroller and California Public Employees’ Retirement System.