The Bush short squeeze

You’ve probably heard that the secret to playing the stock market is to “buy low, sell high”. That’s usually true. However, some investors adjust that advice to “Sell high, buy low.” They're the short sellers.

Readers familiar with stocks may want to skip ahead, but essentially, short selling works as follows:

Shorts look for companies whose share prices are unjustifiably high and due for a fall. They borrow shares in the company from someone who already owns them, and then sell the borrowed shares to another investor. Eventually, the shorts have to return the shares to the people they borrowed them from. But, because they’ve already sold them to someone else, they buy replacement shares at the market price and hand them over to the lenders — in what’s called “covering” their short position. If the share price has fallen, then (ignoring the impact of dividends, margin interest, and so forth) shorts make money.

What’s the downside to selling short? One big risk is that your upside is limited, but your downside is not — the exact opposite of the situation when you invest normally.

If you buy stock in a company (without using leverage), the most you can lose is your total original amount invested. If I buy $100,000 of stock in Google, and Google goes bankrupt, I lose my whole $100,000, but no more than that. On the other hand, if Google continues to grow, there's no telling how much my investment could eventually be worth. The returns on investments in successful companies can be truly staggering. A $100,000 investment in Dell back at the time of its June, 1988 IPO would be worth about $46.9 million today. That's a 46,804% return.

On the other hand, let’s say you think that we’re in the midst of a second Internet bubble, and that Google’s share price is way too high. You sell Google stock short at its current market price.

What's the best return you can hope for from this investment? Well, even if this whole so-called "Internet" thing proves to be a fad and Google goes out of business, there's no way its share price can go below zero. If you had borrowed $100,000 of Google stock against the value of your $100,000 portfolio, the $100,000 you got from selling the borrowed shares is yours to keep — since with the company out of business, you don't have to return any shares to the lender. You're home free, and your $100,000 portfolio has swelled to $200,000. You've doubled your money. Nice work, but your 100% return is a far cry from the 46,804% reaped by investors in Dell's IPO.

Not only is the upside to short-selling limited, but the downside risks are unlimited. Returning to our above example where you've sold Google stock short, let's say the Internet becomes an increasingly vital and inseparable part of our daily lives, and Google grows right along with it. It adds new and unexpected features, acquires former competitors, and branches out into new businesses. While it's already a reasonably large company in terms of market capitalization, there's no telling how big it could eventually become. If Google were to grow as large as Microsoft is now, again in market capitalization terms, its share price would increase more than five times.

Imagine sitting on your short position in Google while that happens. You still have to buy back shares on the open market to repay the guy who lent them to you, but instead of $100,000, those same shares now cost $500,000. Not good. You've lost five times your original investment.

In reality, though, short sellers rarely sit around and watch their investments spiral down the drain to a 500% loss. They try to cut their losses and get out as soon as it's clear they made the wrong call. (The pressure to exit a losing position can be even greater if you were using leverage by investing "on margin" — i.e., with borrowed money. If the value of the borrowed shares falls too far below the value of the money you borrowed, you can expect a friendly "margin call" from your broker, demanding you either put up more cash, or close out your short position.)

If it becomes clear that a stock is going up, therefore, its shorts are all going to want to cover their positions at the same time. Desperate to get out of the frying pan before they fall into the fire, they look to buy back shares on the open market as soon as possible. Of course, hordes of desperate buyers have the predictable effect of driving up the share price, which turns up the heat on the remaining short sellers. This vicious circle of frenzied buying and rising prices is known as a "short squeeze."

Something like a short squeeze took place in the days following the Iraq elections, when long-held anti-Bush positions were finally discarded, having simply become too costly to maintain.

The Bush Shorts have been betting against him since right after 9-11, when they warned against invading Afghanistan. It was a trap, we were told. Afghanistan would be our next Vietnam, snaring America just as it had the British and the Soviets before us. (Better for us to turn inward, ran the corollary, and reflect upon why we were so hated.)

After the Taliban, and then Saddam, fell in record time, the Bush Shorts began to suspect that they were investors on the wrong side of a trade, as the value of their positions spiraled sickeningly downward. So, as desperate investors will, they grasped at straws, hoping for a reversal, hunting for reasons why their view could still be right: Moqtada al-Sadr would unite the Sunnis and Shi’ites against us. Ordinary Iraqis resented our presence. The costs of the occupation were too high. Our forces were being stretched too thin. And so on.

In spite of such dire warnings, the occupation hung tough and pressed onward, and Bush’s stock continued to rise. With his November re-election, the Bush Shorts grew increasingly desperate, even panicky, dreading that eventual margin call. It came on January 30th, when Iraqis stared down the threat of insurgent terror attacks and headed to the polls en masse. The last great hope that Iraq might backfire on us simply evaporated. And the shorts dashed for the exits.

Some die-hard liberals issued soul-searching statements, wondering earnestly if they’d been wrong about Iraq, and Bush, all along. They’re the ones who managed to cover their positions in time. But others held on to the bitter end, and now they’re left with nothing. Bankrupt. Kaput.

Mark Steyn reports on one such unlucky fellow:

"They Are Waiting for the Rivers of Blood," proclaimed the headline over Robert Fisk's column in the Independent, another classic for fans of the beloved comic genius to cut out and add to treasured clippings -- such as his coverage of the Afghan war ("Bush Is Walking into a Trap") and his confident assertion that there were no Americans at Baghdad airport and that the blundering Yanks had merely stumbled upon an abandoned RAF airfield from the 1950s.

As it transpired, the only folks waiting for the rivers of blood were Fisky, the BBC, CNN and the rest of the gang, and they'll be waiting a long time.

Fisk and his ilk still cling to the same discredited views they’ve always held. It’s been said that one definition of insanity is doing the same thing the same way a second time, and expecting a different result. By that standard, the die-hard Bush skeptics are stark raving mad.

Professor Juan Cole, at the University of Michigan, is another classic example of a speculator who went bust shorting Bush. Having faulted Bush every step of the way, Cole’s now reduced to quibbling that Iraq’s historic elections weren’t as democratic as the Iranian elections of 1997 — a conclusion of little relevance. (The pertinent comparison would be of the 2005 Iraqi election to those held under Saddam's rule, when he regularly captured virtually 100% of the vote.)

Formerly popular actress Janeane Garofalo, too, lost big on Bush. After Americans dipped their index fingers in blue ink to show solidarity with Iraqi voters, Garofalo sputtered that the gesture reminded her of the Nazi salute.

By now, far from damaging Bush, each new flailing attack by these forlorn souls merely makes them look more foolish. And each new postitive development in the Middle East — such as Arab pressure on Syria to withdraw from Lebanon — pushes the value of their intellectual portfolio down further into negative territory.

As Gerard Baker writes in the Times of London:

Little more than three years after US forces, backed by their faithful British allies, set foot in Afghanistan, the entire historical dynamic of this blighted region has already shifted.

Ignoring, fortunately, the assault from clever world opinion on America’s motives, its credibility and its ambitions, the Bush Administration set out not only to eliminate immediate threats but also to remake the Middle East. In the last month, the pace of progress has accelerated, and from Beirut to Kabul.

...It’s too early, in fairness, to claim complete victory in the American-led struggle to bring peace through democratic transformation of the region. Despite the temptation to crow, we must remember that this is not Berlin 1989. There will surely be challenging times ahead in Iraq, Iran, in the West Bank and elsewhere. The enemies of democratic revolution — all the terrorists and Baathists, the sheikhs, the mullahs and the monarchs — are not going to give up without a fight.

But something very important is happening now, something that will be very hard to stop. And, although not all of it can be directly attributed to the US strategy in the region, can anyone seriously argue that it would have happened without it? Neither is it true, as some have tried to argue, that all of this is merely some unintended consequence of an immoral and misconceived war in Iraq.

It’s time for the Bush doubters to set off in a new direction — or, if none is to be found, to give up all together. Not everyone is good at handling and adapting to risk, uncertainty, and new information. The next time these unfortunate souls are tempted to dip a toe into the murky waters of geopolitical punditry, they might bear in mind some advice from the late Will Rogers: “Buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.”