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In the latest exercise in brilliance, the all knowing and ever powerful deities in Washington (most of whom were not elected) have decided that it makes sense to ban the short selling of stocks of 799 financial companies. Why? Because finance companies said that short sellers are contributing to a decline in their share price.

Banning short selling because it causes a decline in share prices is like banning rainfall in order to prevent the formation of clouds. But even if there was a speckle of truth to this, which there is not, it is precisely these sorts of rules and regulations that:

  1. Make investors even more queasy about getting into the markets. Rethink back to one of the major problems during the 1930s – the rules of the game changed so often and so arbitrarily, that few people were willing to tie up their capital in any significant long term project. One day they might be subsidized to do it, the next they might have an excess profits tax levied on them, the next they might be prevented from exporting goods, or prevented from importing important raw materials, the next they might be asked to plow every third row under so to speak, and so on. The same thing will happen in financial markets. When the rules of the game are changed midway, not only is that unfair to those who were playing by the rules, but it will prevent others from wanting to play the game. I am leaning, for example, toward putting all of my money in international index funds. That is capital flight, and is something that is NOT good for the economy in either the short or long run (it can be in a world without protectionism).
  2. Incentivize intelligent people to work around those rules and regulations! If you think stopping short selling will prevent people from finding ways to make money on bets that a stock is headed for the toilet, think again. Do you think it was an UNREGULATED, cowboy capitalist economy that led to the explosion in the use of complex derivative transactions? Think again.It was quite the opposite.
  3. If preventing short-selling is actually successful at keeping struggling companies afloat, then when the ban on short selling ends, prepare yourselves for a pretty severe crash. Rather than the price of a company’s stock being allowed to reflect full information about the quality of that company, preventing its price from falling now will only lead to a more dramatic decline in the future, if in fact the company is in trouble.
  4. Following the logic of this new rule, why don’t we just ban the sale of any security whose price falls? In other words, no one is permitted to sell a security for less than the price that they purchased it for?

One Response to “It Rarely Rains When it is Sunny Out”

  1. Jake says:


    If what is mentioned in the article was discovered to be factual, would it not be wise to temporarily halt short-selling? The market in the mean time has other methods of price discovery (albeit less efficient) through the normal transaction of shares, right?

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