Jeremy Warner: A short-selling ban that should be extended

The British short-selling ban on financial stocks comes to an end in a couple of weeks. Should the Financial Services Authority be extending it, as MPs demand?

Thus far, the policy can hardly be judged a rip-roaring success. Many share prices have continued to plunge despite the fact that you can no longer short them, while there is some evidence to suggest that, deprived of financials, short sellers have merely moved on to target other sectors not affected by the ban. The problem has thus been moved, not eradicated.

In short, the ban stands condemned as a blatant piece of knee-jerk politicking – a Dangerous Dogs Act for our credit-crunched times – which has not only proved ineffective but, worse, has succeeded in introducing new distortions into the market. However uncomfortable it might be, sellers have to be allowed to do their worst.

That's the case for the prosecution, anyway. Yet I'm inclined to a rather different view. Part of the problem with the ban is that it was introduced too late to make much difference. By then, the shorters had already sucked the life blood out of the banking sector and the shorting had become a self-fulfilling prophecy, with the collapse in confidence feeding on itself to create recession and bad debts.

John Paulson, George Soros and other speculators now applauded for having predicted the future with pinpoint accuracy through their utterances and trading strategies are, in fact, guilty of greatly exaggerating a crisis whose main characteristic has been a downward spiral in financial and economic confidence.

Banks are, at root, little more than elaborate excercises in investor trust. By borrowing short and lending long, they perform the vital function of maturity transformation without which no modern economy could function. But they depend crucially on confidence to stay afloat. If everybody wants their money back at the same time, they are in no position to pay.

Short traders greatly contributed to the breakdown in confidence that now bedevils banking and the wider economy. It's all very well selling a share that you actually own, but there is something obviously immoral in selling securities that you don't in the hope that eventually you create such blind panic that the underlying company goes bust.

The likes of Mr Paulson didn't so much as correctly predict the future as help to create it. It's easy and not particularly clever to forecast mass murder if you actually intend to go out and commit it. Banning the invidious activity of short selling is perhaps the least the hedgies can expect by way of punishment.

But across the board, those who lend the stock that enables short selling to occur need to re-examine their practices. Can it really be in the interests of long-only clients willingly to participate in this wholesale slaughter of the equity markets?