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Buffett quit shorting over Western Union
They had figured Western Union was completely insolvent, with a pension hole greater than its market cap and its enterprise value. They sold the stock short, and it went up. So they wrote a report on the case and sent it to friends, and it went up again. They sent it more broadly, and it went up again.
It was not their only short that failed, but it was the final straw. A Western Union certificate now hangs in Buffett's office, next to one from a Dale Carnegie class and one from President Obama. It marks the day he quit short selling.
Both men came away from short selling with a miserable experience, and Berkshire does not short to this day.
Why can a short seller's loss keep growing?
A short seller borrows shares and sells them, planning to buy them back later at a lower price. If the price rises instead, the cost of buying them back rises with it, and a stock price has no upper limit. A stock buyer's loss is capped at the amount paid, while a short seller's loss has no ceiling and the gain is capped at the stock falling to zero. Brokers also demand extra collateral when a short moves against the seller, which can force the position closed at a bad moment.
How does a pension gap hurt a company's value?
A defined-benefit pension promises retirees fixed payments, so the company owes that money the way it owes lenders. When the assets set aside fall short of those promises, the shortfall is a liability. Some analysts add an unfunded pension gap to a company's debt when they calculate enterprise value. The size of the gap depends on assumed discount rates, so small changes in those assumptions can move it substantially.
How does a short squeeze push prices higher?
When a stock rises, short sellers who buy shares to close their positions add demand, which pushes the price up further. That forces more short sellers to buy, and the cycle feeds itself. In October 2008, a squeeze in Volkswagen shares briefly made it the most valuable listed company in the world by market value. Squeezes tend to be sharpest when few shares are available to trade.
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