Jeremy Warner: America moves in on short sellers


Outlook It's the way with regulators. With perfect timing in July 2007 as the bull market was reaching its zenith, the US Securities & Exchange Commission abandoned the "uptick" rule, a measure originally introduced as far back as the Great Depression to limit the supposedly damaging consequences of speculative short selling.

There followed a veritable orgy of short selling, particularly of bank stocks and other financials, the like of which the world has never seen before. Now, with the damage done and the short-selling splurge having largely run its course, the SEC is thinking of reintroducing the uptick rule afresh.

The SEC thus conforms to a familiar pattern: deregulate just when markets need to be hemmed in most and then, after the horse has bolted, pile it all back on again. In truth, this is the point at which markets need it least. The salutary lessons of the last bust will make them well-behaved of their own accord for years to come. Hey ho.

The best defence of "shorting" – or selling shares you do not actually own in the hope of turning a profit by later buying them back at a lower price – is that it improves liquidity, the speed of price discovery, and therefore the efficiency of capital allocation.

Yet in unstable conditions, it can also help provoke capital-destructive market panics. Negative rumour-mongering and analysis in combination with heavy shorting have greatly contributed to the banking crisis by undermining confidence and causing depositors and investors to retreat to safe havens.

The fact that short-selling hedge funds have turned out eventually to be right about the banks is neither here nor there. Banking is all about confidence. By helping to trash it, shorting has accelerated, or even helped cause, the failure of banks and the need for hundreds of billions of pounds in bailouts from taxpayers. Never before have short-selling speculators succeeded in so profitably creating such a gigantic self-fulfilling prophecy.

Apologists will argue that it was market fundamentals – too much leverage in conjunction with overvalued companies which had failed to prepare for bad times – rather than shorting that drove stock prices down. Yet it is hard to believe prices got so low simply because traditional long holders got out of their positions.

The purpose of stock markets is to put those who need capital in touch with those who can provide it, and, by allowing shares to be freely traded, supply a mechanism for pricing equity risk. Shorting fulfils no obvious part of this function. The sustained selling pressure it generates is entirely artificial in nature, in that shorters don't actually own the stock they are selling.

Personally, I cannot see the harm in reintroducing the "uptick" rule, which doesn't attempt to ban short selling outright, but only to limit its self-fulfilling attributes by preventing such trades unless a share price is moving up in value.

That's a deterrent, but it is not a prohibition, so it seems a reasonable compromise between the sometimes conflicting calls of financial freedom and well-ordered markets. If there's an uptick rule, it might be argued, why not also have a matching downtick rule to deal with the irrational exuberance of investors during a bull market? As we have discovered to our cost, stock-market bubbles can be just as harmful as crashes. The one leads inevitably to the other. Why not regulate the longs as well as the shorts?

Well maybe, but the point of regulation is to prevent the free-market system imploding at vast cost to the taxpayer as it has done over the last two years. Short selling has contributed to the collapse in confidence and the downward spiral in asset prices that lie at the heart of the crisis.

In that sense, the effect of shorting is not so dissimilar to mark-to-market accounting, which likewise has helped magnify and exaggerate the crisis by forcing recognition of temporary declines in asset values and therefore created problems of solvency and liquidity for banks and other financial institutions.

There's a big lobby in defence of shorting, a practice which has helped greatly to increase the volume of trading in shares in recent years and therefore the commissions that are earned from it. But does short trading really help profit the wider economy? It is hard to see how.

Suggested Topics
PROMOTED VIDEO
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Life and Style
tech
Arts and Entertainment
'Molecular Man +1+1+1' by Jonathan Borofsky at Yorkshire Sculpture park
tv
News
Glamour magazine hosts a yoga class with Yogalosophy author Mandy Ingber on June 10, 2013 in New York City.
newsFather Padraig O'Baoill said the exercise was 'unsavoury' in a weekly parish newsletter
Extras
indybest
News
people'She is unstoppable', says Jean Paul Gaultier at Paris show
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

2 x Risk Analysts Required - SAS - Banking

competitive: Progressive Recruitment: A world leading banking organisation are...

Brady Business Analyst - Syseca - (EBIS / EDIS) - London

£500 - £1000 per day: Harrington Starr: Harrington Starr are urgently recruiti...

Systems Accountant

£75000 - £100000 per annum: Cameron Kennedy Recruitment: We urgently require f...

Investment Banking Sales Manager

£40000 - £50000 per annum + competitive package: Orgtel: Investment Banking Sa...

Day In a Page

The true Gaza back-story that the Israelis aren’t telling this week

The true Gaza back-story that the Israelis aren’t telling this week

A future Palestine state will have no borders and be an enclave within Israel, surrounded on all sides by Israeli-held territory, says Robert Fisk
A History of the First World War in 100 Moments: The German people demand an end to the fighting

A History of the First World War in 100 Moments

The German people demand an end to the fighting
New play by Oscar Wilde's grandson reveals what the Irish wit said at his trials

New play reveals what Oscar Wilde said at trials

For a century, what Wilde actually said at his trials was a mystery. But the recent discovery of shorthand notes changed that. Now his grandson Merlin Holland has turned them into a play
Can scientists save the world's sea life from

Can scientists save our sea life?

By the end of the century, the only living things left in our oceans could be plankton and jellyfish. Alex Renton meets the scientists who are trying to turn the tide
Richard III, Trafalgar Studios, review: Martin Freeman gives highly intelligent performance

Richard III review

Martin Freeman’s psychotic monarch is big on mockery but wanting in malice
Hollywood targets Asian audiences as US films enjoy record-breaking run at Chinese box office

Hollywood targets Asian audiences

The world's second biggest movie market is fast becoming the Hollywood studios' most crucial
Grindr founder Joel Simkhai: 'I've found love on my dating app - and my mum keeps trying to hook me up!'

Grindr founder Joel Simkhai: 'I've found love on my dating app'

Five years on from its launch and Grindr is the world's most popular dating app for gay men. Its founder Joel Simkhai answers his critics, describes his isolation as a child
Autocorrect has its uses but it can go rogue with embarrassing results - so is it time to ditch it?

Is it time to ditch autocorrect?

Matthew J X Malady persuaded friends to message manually instead, but failed to factor in fat fingers and drunk texting
10 best girls' summer dresses

Frock chick: 10 best girls' summer dresses

Get them ready for the holidays with these cool and pretty options 
Westminster’s dark secret: Adultery, homosexuality, sadomasochism and abuse of children were all seemingly lumped together

Westminster’s dark secret

Adultery, homosexuality, sadomasochism and abuse of children were all seemingly lumped together
A History of the First World War in 100 Moments: Dulce et decorum est - a life cut short for a poet whose work achieved immortality

A History of the First World War in 100 Moments

Dulce et decorum est: a life cut short for a poet whose work achieved immortality
Google tells popular music website to censor album cover art in 'sexually explicit content' ban

Naked censorship?

The strange case of Google, the music website and the nudity take-down requests
Howzat! 8 best cricket bats

Howzat! 8 best cricket bats

As England take on India at Trent Bridge, here is our pick of the high-performing bats to help you up your run-count this summer 
Brazil vs Germany World Cup 2014 comment: David Luiz falls from leader figure to symbol of national humiliation

David Luiz falls from leader figure to symbol of national humiliation

Captain appears to give up as shocking 7-1 World Cup semi-final defeat threatens ramifications in Brazil