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.

3 thoughts on “New Oriental vs. Muddy Waters: A Less Than Stunning Revelation

  1. bystander

    It seems to me that investors who jump in and out of the market by the month or quarter are (or should be anyway) pros who don’t deserve sympathy. They are in the business of gaming short-term fluctuations, a kind of gambling. Win some lose some, can’t stand the heat get out of the kitchen, etc.

    But the elephant in the room here is that companies who are listing on public exchanges using falsified accounting data and falsified corporate profiles are doing more than anyone to f*ck up our financial system. They are taking advantage of gaps in compliance mechanisms to quickly flip their positions in shady companies on public exchanges. It’s hard to think of anything that will more quickly undermine the integrity and proper functioning of financial markets than that.

    To be more specific, the article makes the argument, basically, that if we could wait things out, all would be well, because share prices would ultimately reflect reality. this misses the point that if fraudsters are able to publicly list a company and sell their position before the fraud is exposed, the damage and loss is permanent. The only recourse is outside the market — legal action against them, and in the case of repatriated earnings had by flipping shares this is essentially impossible. This isn’t something that the market mechanism of pricing can take care of by itself.

  2. Fredrik

    Well it’s speculation week so any new accusation, baseless or not, will have more time to cause damage than normal.

    Also did you notice the great little change in what the link address tells us was the original title of the piece and what’s currently there?

  3. ken wren

    well written and very perceptive. i work in the industry. it’s blatantly clear. only academics in ivory towers can ignore teh real world evidence and keep claiming efficiency. they confuse ‘hard to beat’ with efficiciency and/or rationality. just because something is hard to beat (most people lose money or fail to beat the market) doesn’t mean it is right. an irrational mob almost always wins in the short term. and market is almost always wrong in the short term, enabling a group of people in my profession to earn a living consistently. but the academics ignore these facts and prefer to think of us as being just lucky. that’s fine in itself esepcially if you are making a nice living out of the system, like us. But seriously this inefficiency costs our economy a huge amount in terms of misallocation of capital and cost of capital. the financial market/industry is simply too big. there are too many people, too many hangers-ons in the industry, trading noise/generating noise. that it tends to attract our brightest and the most ambitious just doubles its damage to the economy as a whole. the analogy of it being a cancer is particularly apt. I am all in favour of more regulation that cuts the industry down in size and streamlining it, eliminating the surplus of noise generators/traders in the industry.