Comments (15)

• Matthew

  One little point. Regarding how markets might adapt to the ban:

  ..pessimistic investors might buy put options...

  There are a handful of firms that specialize in writing such put options. Those firms are able to do so without taking undesired market exposure by short selling the underlying security. If the ability for them to hedge themselves is taken away, they will be less willing (if at all) to write put options and the premiums to obtain them will rise.

  I don't disagree that markets will find ways to get around the regulation, but the point is that this ban is indeed awful and difficult to sidestep.

  Published: October 9, 2008 8:58 AM

• Michael A. Clem

  No, the winners are the managers of the protected (poorly performing) firms, who are able to keep the market capitalizations of their firms above water by denying the rest of us useful information.
  
  So the ban on short selling helps the bad firms avoid their problems. Nice.
  

  Published: October 9, 2008 9:09 AM

• David Ayres

  First of all, this is a great article, very useful to people that don't understand what short selling means, as well as other financial terms that most of us aren't familiar with.

  Is it me, or does it seem as though the financial sector has made things complicated when it comes to investing? I'm not a stupid person, honestly, but this financial stuff just seems confusing to me, and part of me thinks it was designed that way to keep most of us confused and disinterested so we have to rely on others, such as government, to "protect" us from all the confusion.

  Don't get me wrong, I want the government completely out of the financial sector minus protection from outright fraud, theft, etc. I'm a firm believer in the free market. But it just seems "fishy" to me for some reason.

  Maybe it's just due to my lack of knowledge in this area.

  Kind regards,

  David

  Published: October 9, 2008 9:35 AM

• joebhed

  Pity, what?

  Published: October 9, 2008 9:50 AM

• John Trudgian

  I think we need to distinguish the crucial difference between covered short selling and naked short selling. By naked short selling I am referring to the essentially fraudulent practice of selling shares not in possession and then failing to deliver them to the clearing house – the DTC – for onward transmission to the purchaser.

  In order to complete a fail-to-deliver the DTC creates shares out of thin air to satisfy the purchaser. This loophole in reality is designed to allow genuine broker errors to be corrected ex post and thus keep the flow of trades running smoothly.

  By gaming this loophole, unscrupulous short sellers are able to create "phantom" shares which can “live” forever in the virtual world of Wall Street. This effectively allows brokers – aka Wall Street - to dilute and debase long term shareholders – aka Main Street. The volume of phantom shares can be staggeringly high – more than the entire legitimate share issue. In fact there is no limit on the DTC’s digital printing press.

  This kind of activity is far from trivial and can bankrupt small companies by closing their access to the secondary market. Naked short selling is far more rampant and destructive than is widely understood. Yet there seems no effective mechanism, or will, to police this abuse or prosecute the fraudsters. It is a racket, pure and simple.

  The reason the SEC took the rather drastic measure of banning short sales of financial firms was to cover up this weakness in the stock delivery enforcement regime which has long served the interest of Wall Street rather than Main Street. It was only when Wall Street itself became the target of waves of phantom shares being sold short that action was taken.

  This is where the authors have misjudged their paper. The interesting questions are not about ideology – but about money, power and politics. But then in economics they always are, aren’t they?

  For more information on naked short selling and recent examples, point to:

  http://www.overstock.com/11148/static.html
  

  Published: October 9, 2008 10:34 AM

• Yancey Ward

  It is probably only a matter of time before selling stock is restricted.

  Published: October 9, 2008 10:51 AM

• LP

  Short Selling leads to sharper drops, better price discoveries and nasty short covering rallies.

  Had short selling been allowed, The Dow may have hit 9000 on Monday, but it may also be sitting at 10,500 after a nasty short term rally.

  However, I do agree with the ban on Naked Shorts. But then again those rule have been on the books for tens of years and never enforced.

  Published: October 9, 2008 11:35 AM

• James R

  @John Trudgian:

  The SEC's ban was on all short selling, not just naked short selling.

  Also, I think it's pretty clear that Art and Robert were referring to short selling in general, not naked short selling—the only reference they made to naked short selling was a parenthetical note.

  Art and/or Robert: if you're watching the blog comments, could you comment on naked short selling?

  Thankfully, the SEC's ban on short selling expired last night, and based on news articles, the general consensus seems to be that it made matters worse. Hopefully this will discourage further bans against short selling.

  Published: October 9, 2008 11:44 AM

• Bob Murphy

  Hi everyone,

  I have to be very brief, but here is the latest expression of my evolving :) views on naked shorting.

  Published: October 9, 2008 5:31 PM

• Alex

  I'm surprised that so many of you are against naked short selling - Murphy had an article on this that, I thought, was pretty reasonable.

  Objections, Bob?

  Published: October 9, 2008 6:42 PM

• Charlie

  Would short selling even exist in a free market economy?

  Imagine two competing stock exchanges. One allows shares to be borrowed and sold short, the other does not.

  Would you rather buy stock on the exchange that permits shares to be borrowed and sold by traders who have a vested interest in seeing the price decline, or on the exchange that does not permit this practice?

  Furthermore, if you headed a legitimate company that qualified for listing on both exchanges, on which exchange would you prefer to list your stock?

  If I had such a choice, I would *never* trade on an exchange that permits short selling, naked or otherwise. I'm betting that a vast majority of stockholders would agree.

  Published: October 10, 2008 5:46 PM

• Beau

  I notice that in your article about Short selling, you do not discern the difference between short selling and "Naked" short selling which is a totaly different practice that any sane person can understand should NEVER be permitted for any stock, anywhere, anytime. There is a very great difference. A Naked short sale describes a sale in which the seller never owned or possesed the item he sold to begin with and it is done every day, in the market, even though it is actually illegal. Naked Short selling is like selling your neighbors hours without askiing him if you can, and then pocketing the proceeds and just sort of forgetting to tell anyone what you just did. If you don't think that is wrong, Why don't you try it and see how far you get? Also for some reason, only the stock market likes to overlook this naggiing bit of truth and condone this fraud. There is nothing wrong about selling anything you own, but it is immoral, a complete fraud and a lie to sell something you don't have to someone who does not know you actually don't have anything to deliver. That is why "Naked"short selling is the problem that it is and simple Selling, is not. Don't mix and confuse the two. There are too many "Spin Doctors" and Bottom Feeders out there in the world already.

  Published: October 11, 2008 1:25 AM

• Vangel Vesovski

  I have a small point that should be considered. While I agree with the idea of not banning short selling or naked short selling I have a trouble when failure to deliver events are not punished by the DTC. What we need are truly free markets. That means that shorting should be permitted but that contracts have to be enforced.

  Published: October 11, 2008 12:08 PM

• Allen Charles

  I do not believe any owner of any stock would agree to have his stock lent out to be used in any method of trading that eventually caused the value of the stock to fall. The small investor that has a 401k to invest in the market is always the loser of these usually very large hedge funds that sell millions of shares at the higher price causing an additional large amount of selling too basically flood the market with shares resulting in the value (demand) to drop and forcing the price lower. This is simply a method of large traders being able to strip the appreciation of a stock’s growth and take out that value and then returning a borrowed stock back to an unknowing owner of the stock at the now lower value.

  I challenge any of you to tell me you would agree to lend your stock to be used in this way. I suspect no one here would agree to having your stock depreciated in this matter. Wall Street knows this and had the power to stop the selling of their stock short and avoided destroying the value of their shares.

  A small 401k investor does not have the power to protect his stock's value.

  Published: May 1, 2009 1:14 AM

• Susanne Trimbath

  Sirs: You repeat a commonly held fallacy that “short selling provides essential information to market participants and helps us update our expectations accordingly.”

  This runs completely contrary to the definition of Markets. In his 1997 book, How Markets Work, Israel Kirzner explains the process: “Disequilibrium prices generate direct disappointment of plans…. Such disappointment can be expected to alert entrepreneurs to the true temper of the market.” Short sellers disrupt this process by altering the appearance of supply and demand for the shares of companies. Short sellers do a disservice to market prices by increasing the supply of shares in circulation. If they deliver borrowed shares then the lender holds a “marker” for the extra shares; if they fail to deliver shares at settlement (“naked short selling”) then the buyer holds a “marker” for the extra shares. In either case, until the short position is closed, there will be extra shares in circulation in the market.
  

  Published: May 13, 2009 2:29 PM