New Oriental vs. Muddy Waters: A Less Than Stunning Revelation

October 2, 2012

In today’s news {yawn}:

New Oriental Education & Technology Group Inc. (EDU) slid from a two-month high as short seller Muddy Waters LLC said it’s “more convinced than ever” that the Chinese education provider is misleading investors. (Bloomberg)

When it comes to short sellers, I’m pretty much neutral. Let ‘em talk trash about their targets, let the aggrieved companies fight back, and then let the market decide. Sounds like a principled, free speech approach, yeah?

But as the games continue, I keep wondering why this is even a big deal. I realize that it costs money to respond to these allegations, but I think in the grand scheme of things, these listed companies have plenty of resources, both in house and by way of outside consultants, they can bring to bear against scurrilous rumors. There may be a reputational loss, but that can be overcome in the long run if the short sellers are proven wrong.

The real harm, or advantage if you’re the short seller, is the fluctuation in stock price. A short seller report goes out and the stock price dips; the company fires back and the price floats up again. Whoever made bets on that movement took a position on that stock either wins or loses.

But if truth will out, doesn’t all this even out at the end of the day?

Ah. Depends on who you are, I think. If you’re a long-term investor who did her homework on one of these target companies, then you probably sit tight, relying on your due diligence and confidence in the company. If you’re right, that stock price will most likely come back up, and you’ll be fine. If you screwed up and the short seller is right, then you take a bath.

On the other hand, if your world is all about fluctuations that occur over the course of a quarter, or a month, week or even a day, then you could be in serious trouble when a short seller strikes. (For the companies themselves, of course, short term problems can effect credit, solvency, etc., so I am simplifying this a bit.)

So whose fault is all this? Simple, it’s our collective fault for relying on an often irrational financial system that is incredibly sensitive to short-term changes. Doesn’t have to be that way, but that’s what we have created. Without such an emphasis on the short term in terms of price/performance, this whole drama about short sellers would be a lot less compelling.

Does anyone out there really enjoy having your boss constantly peering over your shoulder, occasionally interrupting your day with “The Firm isn’t pleased with your performance over the past 18 hours. Step it up or we may be forced to make some changes.” Sadly for some people, this is only a minor exaggeration. Of course, you can scale this up from a single employee to a company’s quarterly financials to the performance of an entire portfolio.

This is the same “instant gratification” problem that has infected politics, the media and even the way we entertain ourselves. I’m sure there are folks out there who would argue, perhaps even with some serious-looking math to back them up, that the current architecture of the financial system is simply the most efficient. My reply to that: you’re fooling yourselves. We don’t like to admit it when we’re wrong, and we are really good at justifying our decisions post hoc.

So if you work in a particular industry, it’s human nature for your monkey brain to come up with arguments as to why it’s the bestest thing out there since sliced bread – I do it with law firms and lawyers all the time. And when it comes to the Wall Street crowd, let’s face it, the folks in the financial services sector think that the “Always Be Closing,” “Greed is Good” and “Kill What You Eat” mentality is damn sexy, and many have convinced themselves that it must also be good for society. Ha ha ha.

Which leads to me to the following startling conclusion: our current financial system is pretty fucked up. Pardon the melodrama, but short selling is merely one symptom of the disease.