The hedge funds are the speculators in this case. They're playing a dangerous game where you can short more stock than what actually exists. Why this is allowed? Who the fuck knows.
I think this "is allowed" for the same reason that I can borrow a book from you, sell it on Amazon, and when you ask for your book back, buy a copy of that same book on Amazon and give it to you - but in the meantime, the person who bought your book from me can lend it to yet another person, who does the same as me.
In other words, this works simply because stocks can be sold and borrowed, and they don't carry provenance with them. To stop this, you'd have to do the equivalent of DRMing books and revoking the first sale doctrine. Which I imagine would turn shorting into a much more complex market mechanic than it is today.
(Disclaimer: the extent of my expertise on stock markets is me knowing how to spell "stonks".)
You could stipulate, though, that the outstanding short position mustn't exceed the net position, or equivalently that the total long positions can't exceed twice the net position. Why not? (This would require new regulation, but not be impossible, I think.)
If the total long or short positions exceed the underlying economics by a lot, you create all sort of weird incentives for manipulation, as can be seen in the CDS market sometimes.
You could stipulate whatever you wanted, but there is nothing special about that threshold in particular.
I fully agree that derivatives can create all sort of problems in many cases, including when the nominal amount of the positions is much higher than the actual amount of the underlying.
Agreed fully. The 2x long, -1 short limit is just a neat, natural limit that one could discuss, and might be easier to enforce than other (similarly arbitrary) limits.
Why? My broker doesn't let me trade unsettled funds, even though I've made a sale and they're "in my account." How hard would it be to create a restriction that says you're not allowed to double-loan the obligation to return a share borrowed in a short sale?
Because when you buy a share on the market there is no notion of it being "a true share that someone sold to you" or "a borrowed share that someone sold to you". The only way to prevent double-lending is to prevent all lending.
How do you know that the stock was loaned in the first place? If there is a way to know is there a way I can buy the original non-borrowed one - this should be worth more money because I can borrow it to someone else.
The hedge funds are the speculators in this case. They're playing a dangerous game where you can short more stock than what actually exists. Why this is allowed? Who the fuck knows.