Analysis of 265,000 rows of SEC Short Fails-to-Deliver data on Game Stop
One of the key issues with failure to deliver is that market-makers get an exemption under Reg SHO whereby they don&#x27;t have to locate borrowable shares before selling short for &quot;bona fide&quot; MM activity like delta hedging or offering stock. If an investor were to own every share of a stock, and were to refuse to lend shares to other market participants, a market-maker would still be allowed to sell that stock short. If he were to cover it the same day, it wouldn&#x27;t even trigger a failure to deliver. And as long as he keeps buying and selling shares on a brief time horizon (This would be a &quot;reset transaction&quot; if anyone else were to do it, but for a market-maker it&#x27;s arguably part of a day&#x27;s business), he will never end up at the front of the queue of short-sellers who need to buy in shares at open market to make good on delivery three days after a failed settlement.<p>One of the vulnerabilities of the way US markets implement short-selling is that the ability to sell shares before borrowing them can temporarily create phantom shares, and the buyer has no idea. Plus, borrow&#x2F;rehypothecation is recursive. This means that you can lend a share to the same person who sold it to you so that he can sell it to you again. The risk of this in a FTD situation, in my mind, could be reminiscent of a stack overflow...think of the float as memory. Fortunately the CNS system should be able to catch these alterations in the perceived number of tradable shares, but what happens when the FTD rate becomes substantial and persistent, as with $GME? Do those fake shares simply create artificial supply until the short-sellers eventually get forced to buy in, five days later?<p>Another weakness is that it gives market-makers the power to put downward pressure on prices during upside breakouts. Then, once they generate calm, the liquidity comes back and they can cover the artificial supply. Surely some would view this as a force for good, a control on market exuberance. However, imagine what this would mean in a commodity market -- buyers are unaware that the thing they bought doesn&#x27;t exist, and the clearinghouse is responsible for ensuring that they get it. Also, it allows market-makers to create situations where they get paid free money, because all speculators who were betting on a surge by buying shares must then turn around and cross the bid&#x2F;offer spread the other way to close out.<p>In a market with a total capitalization in the tens of trillions, it doesn&#x27;t make much sense to deposit a thousandth of that much money into a collateral fund for a clearinghouse and say &quot;you take care of it.&quot; And make no mistake, they are the ones who do the rejiggering, because FTD means that the clearinghouse is short to the buyer until the seller acquires and delivers the security.