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
News
A 1930 image of the Karl Albrecht Spiritousen and Lebensmittel shop, Essen. The shop was opened by Karl and Theo Albrecht’s mother; the brothers later founded Aldi
people
Arts and Entertainment
Standing the test of time: Michael J Fox and Christopher Lloyd in 'Back to the Future'
filmA cult movie event aims to immerse audiences of 80,000 in ‘Back to the Future’. But has it lost its magic?
Arts and Entertainment
Flora Spencer-Longhurst as Lavinia, William Houston as Titus Andronicus and Dyfan Dwyfor as Lucius
theatreThe Shakespeare play that proved too much for more than 100 people
News
exclusivePunk icon Viv Albertine on Sid Vicious, complacent white men, and why free love led to rape
PROMOTED VIDEO
Arts and Entertainment
Stir crazy: Noel Fielding in 'Luxury Comedy 2: Tales from Painted Hawaii'
comedyAs ‘Luxury Comedy’ returns, Noel Fielding on why mainstream success scares him and what the future holds for 'The Boosh'
Life and Style
Flow chart: Karl Landsteiner discovered blood types in 1900, yet scientists have still not come up with an explanation for their existence
lifeAll of us have one. Yet even now, it’s a matter of debate what they’re for
Arts and Entertainment
'Weird Al' Yankovic, or Alfred Matthew, at the 2014 Los Angeles Film Festival Screening of
musicHis latest video is an ode to good grammar. But what do our experts think he’s missed out?
Sport
New Real Madrid signing James Rodríguez with club president Florentino Perez
sportColombian World Cup star completes £63m move to Spain
Travel
Hotel Tour d’Auvergne in Paris launches pay-what-you-want
travelIt seems fraught with financial risk, but the policy has its benefits
Arts and Entertainment
booksThe best children's books for this summer
Life and Style
News to me: family events were recorded in the personal columns
techFamily events used to be marked in the personal columns. But now Facebook has usurped that
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Latest stories from i100
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

Programme Director - Conduct Risk - London

£850 - £950 per day: Orgtel: Programme Director - Conduct Risk - Banking - £85...

Business Analyst (Agile, SDLC, software)

£45000 - £50000 Per Annum + excellent benefits: Clearwater People Solutions Lt...

Finance Manager - Bank - Leeds - £300/day

£250 - £300 per day + competitive: Orgtel: Finance Manager - Accountant - Bank...

Compliance Officer - CF10, CF11, Compliance Oversight, AML, FX

£100000 - £120000 per annum + BONUS + BENEFITS: Harrington Starr: A leading fi...

Day In a Page

Noel Fielding's 'Luxury Comedy': A land of the outright bizarre

Noel Fielding's 'Luxury Comedy'

A land of the outright bizarre
What are the worst 'Word Crimes'?

What are the worst 'Word Crimes'?

‘Weird Al’ Yankovic's latest video is an ode to good grammar. But what do The Independent’s experts think he’s missed out?
Can Secret Cinema sell 80,000 'Back to the Future' tickets?

The worst kept secret in cinema

A cult movie event aims to immerse audiences of 80,000 in ‘Back to the Future’. But has it lost its magic?
Facebook: The new hatched, matched and dispatched

The new hatched, matched and dispatched

Family events used to be marked in the personal columns. But now Facebook has usurped the ‘Births, Deaths and Marriages’ announcements
Why do we have blood types?

Are you my type?

All of us have one but probably never wondered why. Yet even now, a century after blood types were discovered, it’s a matter of debate what they’re for
Honesty box hotels: You decide how much you pay

Honesty box hotels

Five hotels in Paris now allow guests to pay only what they think their stay was worth. It seems fraught with financial risk, but the honesty policy has its benefit
Commonwealth Games 2014: Why weight of pressure rests easy on Michael Jamieson’s shoulders

Michael Jamieson: Why weight of pressure rests easy on his shoulders

The Scottish swimmer is ready for ‘the biggest race of my life’ at the Commonwealth Games
Some are reformed drug addicts. Some are single mums. All are on benefits. But now these so-called 'scroungers’ are fighting back

The 'scroungers’ fight back

The welfare claimants battling to alter stereotypes
Amazing video shows Nasa 'flame extinguishment experiment' in action

Fireballs in space

Amazing video shows Nasa's 'flame extinguishment experiment' in action
A Bible for billionaires

A Bible for billionaires

Find out why America's richest men are reading John Brookes
Paranoid parenting is on the rise - and our children are suffering because of it

Paranoid parenting is on the rise

And our children are suffering because of it
For sale: Island where the Magna Carta was sealed

Magna Carta Island goes on sale

Yours for a cool £4m
Phone hacking scandal special report: The slide into crime at the 'News of the World'

The hacker's tale: the slide into crime at the 'News of the World'

Glenn Mulcaire was jailed for six months for intercepting phone messages. James Hanning tells his story in a new book. This is an extract
We flinch, but there are degrees of paedophilia

We flinch, but there are degrees of paedophilia

Child abusers are not all the same, yet the idea of treating them differently in relation to the severity of their crimes has somehow become controversial
The truth about conspiracy theories is that some require considering

The truth about conspiracy theories is that some require considering

For instance, did Isis kill the Israeli teenagers to trigger a war, asks Patrick Cockburn