NationStates Jolt Archive

A straight debate is in order. It's a technical issue, there should be a right answer.

The subject: http://www.investopedia.com/university/shortselling/shortselling1.asp
When an investor goes long on an investment, it means she has bought a stock believing its price will rise in the future. Conversely, when an investor goes short, he is anticipating a decrease in share price.

Short selling is the selling of a stock that the seller doesn't own. More specifically, a short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered. That may sound confusing, but it's actually a simple concept.

Still with us? Here's the skinny: when you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.

Argument Pro: http://www.businessspectator.com.au/bs.nsf/Article/Stemming-the-tide-JM6L6?OpenDocument&src=sph
The FSA’s ban on short selling followed what appears to have been concerted attacks by hedge funds on HBOS and Barclays and other UK banks. Similar assaults on US banks and investment banks contributed to the implosions in the value of Bear Stearns, Lehman, Fannie Mae, Freddie Mac, AIG and other financial institutions.

This week, Macquarie Bank and Suncorp were subjected to destructive and – particularly for Macquarie – potentially destabilising bear raids.

Short-selling is useful in normally functioning markets. It provides extra depth and liquidity to trading and also helps accelerate the disclosure of corporate weaknesses. These aren’t, obviously, normally functioning markets. There is no long-only fund buying, indeed not much buying from anywhere.

That creates a system-threatening, institution-destabilising, panic-inducing one-way bet for the hedge funds – there is no resistance to the short-selling.

The market purists might argue that short-selling exposes weakness. The problem today is that the hedge fund activity is not just exposing deficiencies that already exist but actually creating them through their actions.

Given the severity of the crisis, and the destructiveness of the attacks on financial institutions, a temporary ban on shorting that sector – until some semblance of normality returns to securities markets – looks like a sensible step.

Argument Con: http://money.cnn.com/2008/09/19/markets/thebuzz/index.htm?postversion=2008091918
Banning the practice could cause disruptions. "This is borderline insanity - if the SEC had set out specifically to make the liquidity problems worse, they couldn't have done a better job," said William Fleckenstein, president of Fleckenstein Capital, a Seattle-based firm that specializes in short selling. "Guys that are short are like guys that are long. We're just looking to make money."

Second, in the past few years, shorts have often identified fraudulent companies such as Enron, Tyco and WorldCom before many others saw the problems. You can argue that shorts were once again early in identifying banks that were in financial danger.

It is true that short selling may have exacerbated the problems plaguing banks. Rapidly plunging stock prices led to a crisis of confidence that fed on itself and sent prices even lower. And as I pointed out in a column last week, short sellers have been increasingly making bearish bets on banks that are not facing big credit-related problems.

But it's not the fault of short sellers that Lehman Brothers, AIG, Washington Mutual, Wachovia, Merrill Lynch and Citigroup - to name a few - have been bleeding red ink for the past few quarters.

The issue at hand is not that short selling is evil. It is that some short sellers engaged in illegal practices, manipulating the market by spreading rumors to push stocks lower.

It is such manipulation, not the practice of short selling itself, that the SEC should crack down on. The SEC's statement about the ban lacked any mention of how the commission planned to fight fraud.

Instead, the SEC seemed to compare short sellers to kindergartners in need of a nap. The statement Friday morning said that the temporary ban amounted to a "time-out."

The immediate result: http://www.ft.com/cms/s/0/ef5d128c-8677-11dd-959e-0000779fd18c.html
Hedge funds scramble on shorting ban

Hedge funds were forced to scramble to unwind trading positions on Friday after a massive assault by global regulators on short selling aimed at calming the turmoil in global markets.

The US Securities and Exchange Commission joined top market watchdogs in the UK, France, Portugal and Ireland to temporarily ban short-selling and other investors from engaging in trades allowing them to profit from falling share prices of financial companies.

So what do you think? Do you support the ban on short selling for investment purposes (rather than hedging), or not? Why?

I generally don't like the practice of "playing" the stock market. Unlike the actual investors, the dedicated players just extract money out of the market, contributing little. Simply speaking, it is not necessary.

Politically, I'm counter-regulation, but in this, already very free segment, some measures might be acceptable. OTOH, a blanket ban would be overregulation. Some restrictions on the most abusive techniques and keeping the uptick rule would be more like the answer.

As for "the right answer", I'm not qualified to give it, and I don't think anyone here is, and not sure if anyone in the world is, except for visionaries.


P.S. About the poll: Why no return the uptick rule option?

What will we do with the unemployed and unwanted short folk though? You have to think these things through.

I can't quite imagine how you would stop the illegal market manipulations of a few hedge funds, so as stop gap measure banning short selling the financial sector would seem to be a good idea.

But then I'm not sure I agree that shorting is a useful practice in pointing out failing companies. It's making money out of investors who were lied to by the company which would eventually collapse anyway.

Short sellers were just caught out by Volkswagen, which rose against expectations. The point is that short-selling is not a guaranteed paycheck, otherwise everyone would be doing it. Where it does become guaranteed is where a company is perceived to have fundamental weaknesses, and all those that collapsed recently clearly did.

Short selling itself isn't the only culprit, it exploits a weakness, one might say economics goes through an evolutionary process itself.

While it's a largely good idea to stabilize the markets by temporarily banning short selling on financial stocks, in the long term it is actually a pretty bad idea. Most of the stocks that were hurt by short selling, were stocks that were being sold for already flawed companies. Folks like Bear Stearns were significantly overexposed to bad, mortgage backed securities, and when their own internal operations started to hurt, folks sniffed it out, and they sold short. It's a solid indicator of where not to put your money, when people sell short.

As such, I'd advise, very strongly, against a ban. Naked Short Selling, as its called, is possibly one that could be banned...but that's because the person who sells the stock doesn't actually possess it. That's a stranger, and sketchier technique.

While it's a largely good idea to stabilize the markets by temporarily banning short selling on financial stocks, in the long term it is actually a pretty bad idea. Most of the stocks that were hurt by short selling, were stocks that were being sold for already flawed companies. Folks like Bear Stearns were significantly overexposed to bad, mortgage backed securities, and when their own internal operations started to hurt, folks sniffed it out, and they sold short. It's a solid indicator of where not to put your money, when people sell short.

As such, I'd advise, very strongly, against a ban. Naked Short Selling, as its called, is possibly one that could be banned...but that's because the person who sells the stock doesn't actually possess it. That's a stranger, and sketchier technique.
/threadwin

it should be banned only until the crisis is over and the decisions on what to do with all these huge failing companies have been implemented

Yes we should.

If you want to depress the value of stocks across the board, then you will ban short selling. Removing the ability short basically prevents hedging (or at least makes it more expensive or difficult) and therefore makes holding any given stock becomes riskier and therefore the price will go down. It's even worse at times like this when hedging certain companies is almost a necessity, and those same companies probably need access to cheap capital.

Practically suicidal in fact.

And despite all the talk about banning short selling, you can still short. It's just more difficult for small players. Hell, GS operates private exchanges where this goes on right now for big players. Moreover if you are big enough to take large long term short positions, absolutely nothing has changed because you are doing it outside the exchange.

As for bear raids. I will point out that none of the companies that people are panicking about are on the Reg SHO list (list of companies with FTD problems). For years that sort of stuff has been going on making life intolerable for small cap companies, mostly with the collusion of the SEC and the very companies now that are screaming about bear raids. Think on that. It also shows how full of shit most of these investment banker types are.

Of course the theoretical objection to shorting is that it creates phantom shares. I don't think that makes all that much difference though.

Really though, banning lobbying would do more good for the financial markets.

I'm not the most up guy on finance, but I think your poll lacks a bit of nuance.

Overall I'm largely with Vault 10.

Speculative shorting, as opposed to proper investing, is bad for the market.
Uptick Rule needs to be reinstated.
Naked shorting needs to be stopped.
I'm not really up enough on financial markets to geive a more in depth answer.

Yes it should have a temporary ban. However put the rules back in place that were taken out in the US such as the uptick rule. That way there is some braking mechanisms. I also heard that there was massive short selling of stocks that were not even on the books. How the hell can a system work if that is allowed?

There are many factors that brought us to this current state however the short selling issue is specifically because rules were loosened by congress no less. So fix it like it was and let it resume.

We should absolutely ban short selling. Small people are not cattle; they have the same rights as anyone else.

Short selling is no different than long selling but unlike long selling, it is much more risky and has a definite limit to what you can make. With a long position, your potential profit is unlimited. With a short sale it can't be more than the price you sold at. With a long position, you can't lose more than what you paid. With a short position, your loss is theoretically unlimited. Remember the old saying "he who sells what isn't hisin, makes it good or goes to prison."

Short selling got/gets it bad name from insider trading rather than from the concept. As others have pointed out, banning short selling will only affect the little guy; so it would be kinda like gun laws, only affect the law abiding portion of the population.

It looks to me like the short sellers do us all a favor by signaling to the general public that they think a company is in trouble. Sure, there may be abuses, but the market can handle that better than it can handle arbitrary regulation.

I don't think so. Banning short selling would likely hide the serious situation in many of these companies; we need to allow them to go under and be brought to government conservatorship for restructuring now, not allow them to conceal their deterioration situation until it's too late to realistically save them. The current crop of short sellers aren't interested in putting these companies out of business, they're interested in salvaging what value they can before these companies go under. And those companies will go under regardless of whether shorts are permitted or banned.

I do believe stronger enforcement needs to be implemented for naked short selling; although I don't think naked shorting should be entirely illegal (since it is a legitimate form of speculation), it definitely needs to be strictly regulated to ensure that it is not manipulated to artificially drive stock prices up or down due to a sudden rush to buy to cover.

Why no return the uptick rule option?
Because it doesn't seem to make much difference. The SEC actually suspended it for a year at first, to allow people to gather data on its effects. And much like the short sellers had been saying, there seemed to have been little.

Speculative shorting, as opposed to proper investing, is bad for the market.
There's little evidence to suggest that's true. Right now markets are in all sorts of excitement, and when things are as volatile as this, and you're going to have a hard time making money from taking long positions, shorting will naturally take on a bigger role. But in general, I don't think you could say it's bad for the market.

Uptick Rule needs to be reinstated.
See above.

Naked shorting needs to be stopped.
The only difference is that you could potentially execute larger trades immediately. But you're still going to have to cough up the shares when the thing is settled, and you take on the extra risk of not being able to find them in time. I don't really see why it's that much worse than covered shorting.

Also found this: http://www.economist.com/displaystory.cfm?story_id=11591349
Nasty, brutish and short
Jun 19th 2008

The life of a short-seller is a hard one—especially when markets turn sour and people look for someone to blame

http://www.informationarbitrage.com/ - another experienced voice calling this ban BS, instituted both for populist and lobbying reasons.

The new rule helps prevent attacks on key institutions right now, which is important. I don't think a permenent ban would be beneficial though. In normal circumstances there is a role for short selling.

Now Australia banned it as well (http://www.businessspectator.com.au/bs.nsf/Article/Australia-blows-up-the-hedge-funds-JPCC6?OpenDocument&src=sph). A big part of it was that the market isn't really large enough to support all those funds and investors who used short-selling in the US and Europe. Any market now left with shorting allowed will become the new home of many, many billions of dollars of money looking to short shares. The smaller the market, the worse the results. Expect the Asian markets to follow suit.

Bunch of idiots really. The last thing we need is more uncertainty, but fundamentally changing the way share markets work is precisely that.

Whether you agree or disagree with short-selling in principle, the effect of today’s decision will be unpredictable.

Stocks will probably rise dramatically tomorrow, as hedge funds cover their positions and a massive source of selling pressure is suddenly removed.

But what will happen to the hedge funds and, more importantly, to their lenders? There is every likelihood that a run on hedge funds will now take place as their investors realise they no longer have anything to offer that is different to long-only funds.

And will the ban on shorting produce an unsustainable spike that will lead to an even bigger crash later? The answer might well be yes.

Several European countries have forbidden it too. As far as I understand it, short selling is just another one of those techniques that strenghten my conviction that the stock market is nothing more but a glorified casino. And we've all seen what all that happy gambling has brought us. There should be more laws prohibiting this kind of reckless behaviour, it's not like the market is capable of regulating itself. Unscrupulous greed doesn't like to be regulated, after all.

Bunch of idiots really. The last thing we need is more uncertainty, but fundamentally changing the way share markets work is precisely that.

U are coming round to my way of thinking. Use this new found knowledge to profit.

I really don't know.

I figure what the heck. A companies leadership can profit off a dying company (golden parachutes, first to claim company assets on closure, etc.) so why not the shareholders?

Now a temporary ban when the market is in freefall. I guess so.....