A recent study by three University of North Carolina researchers indicates that market short sellers profit from their enhanced ability to discern publicly available information, not from market manipulation or insider knowledge.
Common wisdom is that short sellers, those market participants attempting to capitalize on the misfortunes of individual stocks, manipulate or shape negative information to their benefit. The study, reviewed here in the New York Times, and published here, reveals that short sellers are merely very astute and perform a very high level of due diligence. These “informed traders” do not merely time the markets and information, and therefore, obtain unfair advantages over other market participants. Rather, short sellers perform effective due diligence and often prognosticate future failure or scams.
The researchers looked for evidence that short sellers’ informational advantages were due only to timing and “inside information”, and looked for evidence of abnormal short selling ahead of news events in the U.S. over the 2005-2007 period. They found no such patterns, and noted that the “ratio of short sales to total volume is nearly constant around news events.” The researchers actually found that “there is a significant increase in short selling AFTER the news event” which indicates that the short sellers are trading on publicly available information.
Prior research studies indicate that short sellers, for instance, do not tend to trade before earnings announcements. Other studies found no evidence that short sale transactions concentrate prior to bad news events. These results tend to indicate that short sellers may have an “informational advantage” and are informed. The studies also “highlight the importance of looking at more than one news category in assessing short sellers’ behavior, and shows that the information content of news leaves room for traders with different abilities to process the information to arrive at different conclusions about the value relevance of the news.” The recent study contributes to the research by highlighting how short sellers come to enjoy this advantage.
The results indicate that “the public release of information presents trading opportunities for skilled processors of information, that is, when news is released, traders with superior information processing skills can convert this news into variable information upon which to trade…Those traders who show exceptional skill in converting such data into value-relevant information are rewarded with superior returns on event-driven trades.” Specifically, the study found that “short sellers tend to trade at the same time as other traders, and when they do not, they trade after other traders. These results suggest that short sellers do not anticipate news.”
The study’s authors conclude by noting that news stories containing earnings projections, analysts comments and ratings, earnings, joint ventures and product distribution reports were deemed newsworthy by short sellers, but that short sellers possesses an uncanny ability to process the information provided to them.
In our current environment, market regulators and the investing public excoriate short sellers for something they do better than anyone else: perform effective due diligence and reveal market manipulations or scams (think Allied Capital and David Einhorn as just the most recent example). Instead of punishing short sellers for their uncanny wisdom, the SEC and other regulators should be studying their investing styles and the due diligence they perform, as they are often more predictive of future failures and frauds than regulators or other market participants. The SEC, laughably, has become a parody of an effective regulator, especially after the Madoff, Sanford, and Allied Capital scandals.
Market participants should celebrate short selling as an exercise in self-regulation rather than manipulation. Anyone or anything that enhances transparency in a market opaquely unaware of its shortcomings should be promoted rather than punished. Our economy has lived through perhaps the greatest act of self-delusion since the Dutch Tulip crisis, yet many still disdain any attempts to enhance its transparency. Short sellers are but one, isolated bridge to a fair and self-regulated market.

A profound essay suggests that empires operate somewhere between order and chaos, and there comes a moment when great empires can be collapsed by seemingly minor disruptions.
Niall Ferguson, the Laurence Tisch Professor of History at Harvard University, has written a profound analysis of the destruction of empires for the journal Foreign Affairs, reprinted here. Ferguson posits that an empire’s slide into chaos is abrupt and disruptive, rather than gradual and cyclical, as traditionally thought.  

Historically, scholars seemed unified around the notion of gradual decline and phased transitions:

A series of five paintings by Thomas Cole, which hang in the New York Historical Society, depict the fall of empires as a process moving through five stages: lush wilderness, a nascent agrarian idyll, an opulent merchant society, destruction from invading armies, to collapse and desolation in abandoned land.
Historians Giambattista Vico, Oswald Spengler, and Arnold Toynbee share a common vision of destruction as seasonal and rhythmic. Paul Kennedy’s The Rise and Fall of the Great Powers discusses the phenomenon of “imperial overstretch”, the notion that great powers overextend themselves, economically and militarily, and create the very seeds of their destruction.
Similarly, anthropologist Jared Diamond proposes a “green” theory of collapse: that empires destroy themselves by abusing their natural environments. Ferguson notes that Diamond falls prey to the same blunder that traditional historians have made, that whether the cause of collapse is economical, cultural or ecological, it occurs over a protracted period of time, often centuries.
The decline of the Roman empire has been attributed to long-term, collective failures that converged to cause its collapse.
Protracted decline prevents leaders from making changes, as the pain of making immediate and often costly changes is too high when contrasted to the alternative, leaving these issues to future generations to resolve.
The threats facing the United States are often characterized as long-term in nature, the “slow march of demographics”, the economics of an aging population that will eventually overwhelm economic sustainability.

Ferguson suggests that the cyclical nature of destruction as a theory of empire collapse is fundamentally flawed. Empires are complex societies, delicate social, cultural and economic systems that operate fluidly, organically, and in a state of delicate stasis. Sudden, often small events or circumstances, such as those described by Nassim Taleb in The Black Swan, can disrupt this equilibrium and create a crisis of such magnitude that the entire organism collapses.
It is these “proximate triggers” that we must be concerned about, that can cause wide-spread conflagration and destruction of complex systems. Small inputs to these systems can “produce huge, often unanticipated changes – what scientists call the amplifier effect.” “When things go wrong in complex systems, the scale of disruption is nearly impossible to anticipate.”
“Empires exhibit many of the characteristics of other adaptive systems – including the tendency to move from stability to instability quite suddenly.” Ferguson argues that the speed of collapse of the world’s greatest empires strikes against the very notion of cyclical collapse: Rome collapsed in just five decades, the Chinese dynasty fell in little more than a decade, and the French Bourbon monarchy passed from “triumph to terror” in only four years. Within a decade from the end of World War II, the British empire had conceded independence to Bangladesh, Bhutan, Burma, Egypt, Eritrea, India, Iran, Israel, Jordan, Libya, Madagascar, Pakistan, and Sri Lanka.
Ferguson argues that most “imperial falls” are associated with fiscal crises. These crises are marked by “sharp imbalances between revenues and expenditures, as well as difficulties with financing public debt.” What is the implication for the United States? According to Ferguson, “alarm bells should therefore be ringing very loudly, indeed, as the United States contemplates a deficit for 2009 of more than $1.4 trillion – about 11.2 percent of GDP, the biggest deficit in 60 years – and another for 2010 that will not be much smaller.”
He further argues that “over the last three years, the complex system of the global economy flipped from boom to bust – all because a bunch of Americans started to default on subprime mortgages, thereby blowing huge holes in the business models of thousands of highly leveraged financial institutions.” Is this the trigger event for a collapse of American Empire?
Even if his hypothesis is wrong, his argument merits considerable attention. Are we at the end of our American Empire? Is the American Dream dead? Are we at the precipice of a sharp decline in our standard of living and the demise of the American Century, or is this the Great Recession merely a bump in the ascendancy of our Empire? Either way, we are staring at an unprecedented economic event, itself generating a loss of confidence so remarkable and breathtaking that it will likely cripple American bravado for a generation.

State pension funds are significantly magnifying risk and manipulating their expected rates of returns in order to reduce massive shortfalls between actual pension funds on-hand and expected pension liabilities to their retirees.
Following the Pew Center’s Trillion Dollar Gap report on the pension crisis, The New York Times reports, here, that states continue to purposely distort their expected rates of return to prevent their already large pension funding shortfalls from growing steeply. Significantly, states are also concentrating greater portions of their assets in a riskier range of investments, such as commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing in an effort to seek higher returns.
The outright inflation of expected rates of return on pension assets, often pegged at over 8 percent, allows governments to diminish their annual cash contributions to the plans, but ultimately succeeds only in deferring the pain to later years. The fiction of inflated returns on pension assets temporarily closes the funding shortfall and allows governments to ease their current budgetary constraints, but fails to address the fundamental urgency of the crisis: that pensions and retiree health care benefits are grossly underfunded.
Pegging their expected rate of return to a realistic rate could have immediately disastrous consequences, though, and cause marked increases in annual contributions and significantly increase the gap between available assets and expected liabilities. A case-in-point is Colorado, which assumes an 8.5 percent rate of return and a $17.9 billion shortfall. Resetting this rate to a more realistic (yet still high) rate of 8 percent would increase the shortfall to $21.4 billion.
In desperation, state and local governments are also attempting to maximize returns by investing their assets in volatile financial instruments. This, as private companies are increasingly moving their assets towards safer fixed-income instruments, such as bonds, and away from risky instruments or equities. This strategy will merely increase volatility, and subject the pension funds and individuals’ retirement savings to the vagaries of the market and another collapse. The lessons from the last few years remain unlearned by those who manage America’s assets, yet the consequences of these failures are ultimately borne by others.