Where do hedge funds get the stock that they [sell] short in the stock market?

BY Ray Suarez  December 7, 2007 at 1:52 PM EST

Question/Comment: Where do hedge funds get the stock that they [sell] short in the stock market? If, as I suspect, they acquire it from the 401(k) accounts of hard-working individuals who rely on the concept of going “long” in the market, does this make a mockery of the “ownership society?” Institutions can subsequently trade it against the interest and expectations of the passive investor who hopes to retire with a nest egg.

Paul Solman: This is a fascinating question. First off, though, let’s be clear: “hedge funds” do not all sell stock short. Most are long – that is, they’re buying in anticipation of a rise in value. Hedge funds are simply private pools of capital that, because it’s the money of supposedly knowledgeable and well-heeled investors, isn’t subject to much regulation. <

“Short-sellers” are those who borrow stock at today’s price, sell it, and hope it will go down by the time they have to return it. At which point they buy the stock at the now-cheaper price. They wind up making the difference between what they sold for and what they got.

But from whom are the short sellers borrowing? Generally, it is money managers who hold the stock for anyone – insurance companies, pension funds, folks in 401(k). The managers make a small amount of money for lending the stocks.

Since the stocks are borrowed, however, I don’t see how the “ownership society” is really affected. The insurance companies, pension funds and folks with 401(k) plans still own what we did before.