Without the ability to short sell, the market can't even function effectively.
Convertible/Risk arbitrage people cannot do their job wihout short selling. The risk-free spread is there for the taking, but you can't take it.
Options market makers cannot hedge their PUT writes without short selling.
This is what I envision:
We'll see a massive short covering rally caused by a dry up in volumes by next week.
Option traders will stop trading as they cannot properly hedge their postions, as will all risk arbitrage, debenture, derivative and ETF traders. Traders of all financial products will not trade if they cannot hedge their positions.
Liquidity will dry up and volatility will increase drastically, which is exactly what the SEC wants to avoid.
The USA has decided to follow their Russian and Pakistani comrades in artificially controlling the market.
It's over fellas.
We've killed the banks.
Now we'll kill the hedge funds and the options houses.
Kill 'em all. That's how a lot of folks feel, but in reality what we need to re-think is compensation. Hedge funds being paid 1-and-20 and company management getting 99% of comp in call options provides a huge incentive for taking on absurd risk.
My goodness. I don't understand why you invested in those hedge funds in the first place if you thought the managers were overpaid. I wouldn't mind giving Jim Simons his 5% of assets and 44% of gains if I could invest in Rentec. Unfortunately, I'm not a Rentec investor, so his compensation is literally none of my business.
Ok. You'll not only be killing the hedge funds but you'll also be killing the ETF issuers who needs to short sell in order to keep the ETF price in line with the underlying basket of stocks (Some ETF issuers use OTC swaps but at the end of the rope, some party still need to short the stocks to keep the price efficient)
I don't get it. What does that got to do with short selling? If they effect a blanket short sell ban, you're going to see quite a number of business going bust. The ETF business will be derailed. So will the options business. Companies shut down. People get laid off.
If they really want to stop the carnage inflicted on the financials, the should just ban short sells on the financial sector alone.
What about other derivative financial "instruments"? There has been a lot of talk about the shadow banking system and their ability to avoid regulation. Won't these players just step in and sell these "hedges" privately and probably further exacerbate the problem?
One alternative to short selling as a hedge is a structured note linked to inverse performance of a stock. But how scalable is this option? If anything, we are moving backwards with this solution as there would be less transparency in this "unregulated market". Who knows what kind of risk these counterparties will take?
Oh yes, if the hedge funds are forced to cover, this could conceivably lead to some blowups, putting even more pressure on the banks that finance them. Wonderful.
Data point: In China, retail investors are not allowed to short-sell. China's stock market has had an unprecedented rally over the last 2 years (up 600% from Jul 05 to Oct 07) and then an unprecedented collapse recently (down 66% since then).
In econ & finance textbooks, the theoretically predicted result of this is that it exacerbates market swings. When the market is overvalued, there's no check on its upward movement caused by short-selling. When it's undervalued, there's no check on its downward movement from short covering. It's always hard to sort out causation from correlation - there could be dozens of other factors at work - but China's experience seems to support the theory.
As for your appeal to authority, it's possible for the SEC to know more than furiouslol and still do this, as long as they're incentivized to do so. Byrneseyeview's comment on another story here explains how:
I'm totally serious. You can ask anyone who knows about the market and get their candid opinions.
I don't know how long they're going to effect this ban but to give you a preview of what banning short sell can do, just take a look at the China stock market. The chart is like the Eiffel tower.
The shorts make the market effective as they provide a floor at a bottom where no one else may be willing to buy.
I'm all for a permanent ban on naked short sells but to have an outright ban of all short sells is plain stupid.
It's not that I disagree with you, I really don't have enough knowledge to decide. I haven't the slightest clue how long they want to prevent short selling for (I think the article got cut off since I don't subscribe) or what sort of effect that short term action might have.
I was just wondering how you came to the decision that it's stupid. It seems you'd need a lot of knowledge to be reasonably sure of that, given that other people with a lot of knowledge made the decision.
It's too much of a coincidence that this move is effected a few days after McCain publicly chastised SEC Chairman Chris Cox and said he would fire him if he were president.
Has McCain spoken out in favor of something like this? This would seem to be pretty out of line with typical Republican doctrine. I don't see this as being an attempt to save his job, it's clearly not going to happen if McCain is elected.
McCain is often pretty out of line with typical Republican doctrine. I'm not sure the ban is specifically a McCain thing, but it does seem very political. Far fewer people complained about rich Wall Street fat cats when those fat cats got rich by making mortgages cheap; now that a few of them have gotten rich by betting that mortgages would be priced rationally again, folks are upset.
It goes a lot deeper than that. Short selling is actually ruining the ability of financial institutions that aren't even exposed to the mortgage problems (or are minimally so) to get the inflow of credit they need. Or so the argument goes.
Again, I'm not an economist, so I don't have a strong opinion here. What I do know is that people who know a hell of a lot more than me (or probably anyone who posts here) are making these decisions, so dismissing them based on some generalized knowledge (i.e. short selling is bad because my econ 101 textbook said so) seems childish.
That's why I was asking the original commenter if, perhaps, he knew enough about economics to have an informed opinion. For all I know, he has a PhD in it.
It's about shutting up the short sellers, not short selling in and of itself. People with big short stakes have been the ones going through the books and screaming on conference calls and to the media that various companies are toxic. Smart people have made billions in recent months. The government wants to shut them up so it has more time to triage.
But if what those big mouths like Einhorn/Eckman say is true (which it is), wouldn' that be to the benefit of the shareholders? These big mouths have alerted the shareholders of the innate problems in MBI and Lehman months before they capitulate.
Those crashes you've seen lately, I would argue, are the works of an efficient market. Isn't it prescient that the market drove down the price of AIG to near the fair value after the bailout ($2-5), well before it was actually bailed out?
I don't understand enough about the stock market to comprehend the possible unintended consequences, but trying to interfere in the free market can result in things like the 70s fuel crisis.
I'm not sure where we are on the "people never learn / we're screwed enough to need this" continuum, but I definitely don't get warm fuzzies from this. :/
I don't see how they can legally do this. If I borrow some shares from my friend, and sell them (which is what shorting is) - what exactly are they supposed to do?
Prevent me from borrowing shares? Prevent selling shares?
It's between me and my friend about returning the shares to him later.
The only thing I can see is preventing naked shorts - i.e. sell the shares without borrowing them first, and promise to make good on it later.
But covered shorting? Unless you repeal capitalism, I just don't see how it's legal. Or even possible - I could make a website where people can borrow shares for a small fee. What could they do about it?
Can they make a law making it illegal to loan someone shares?
I'm completely against it, but there is a theory that it was a stop-gap to what is being called a "financial" terrorist attack.
Most of the short sales put on this month were from overseas, mainly coming out of London and Dubai. It's still a longshot conspiracy theory.
Even so, the broker/dealers and the SEC have been far too complicit in naked short selling. The rules against this have been in place for years, just never enforced.
I'll echo the posts claiming that a short-sell ban is a recipe for disaster. Short selling isn't just a way of betting on the market declining. It's also a hedging strategy used by arbitrageurs, market makers, and options traders.
Actually, as far as speculative short-selling goes, one can argue that it doesn't do enough in bringing prices to fair values. Here's why. With most stocks, it's possible to sell them short and make near-fair interest on the cash. For example, your clearing firm might charge you 3.8% on money borrowed for long positions, but give you 3.4% on cash held in short positions-- a 40bp spread, which is costly but not a show-stopper for a skilled trader. Although you can't withdraw the money without closing the position, because you have more cash than equity, you're earning interest on the cash component. In cases where a stock becomes hard to borrow, banks will lower the interest rate on cash held, sometimes to negative values. When this happens, the stock inevitably trades higher than a fair market value, because of the penalty involved in short-selling it.
Another danger of short-selling, related to the hard-to-borrow factor, is that clearing firms (banks) can force short-sellers to close out their positions at any time. They're intrinsically limited in how much short interest their customers may hold, and will, on occasion, force less preferred customers to close out, possibly unfavorably, in order to allow preferred customers to short-sell.
In addition to "hard to borrow" securities and short squeezes, speculative short-selling is generally very dangerous, especially in a bubble, for more intrinsic reasons. If you're short a stock, and it goes up in the short term, you must put more money in the account (to build equity to a reasonable level) or close the position, early and unfavorably. There are a large number of people who bankrupted themselves by shorting Nasdaq futures at 3000 in 1999. They thought tech stocks were overvalued, and they were right, but they nonetheless were creamed when the thing shot up to 5000 before coming back down.
Arbitrageurs and market makers are good for markets. They provide a lot of liquidity, meaning that bid-ask spreads tighten and it becomes possible to buy or sell large blocks without moving the market to an unfavorable price. Essentially banning what they do is going to result in complete disaster.
If you're short a stock, and it goes up in the short term, you must put more money in the account (to build equity to a reasonable level) or close the position
No. One might simply add to his position (e.g. short more). It is called "shorting into the rise".
What I meant, and I failed to explain this properly, was that the amount of equity you need to have in the account increases as the stock or index rises, and eventually it can happen that the position requires more money than you have, and you're hit with a margin call. You're correct that if you already have enough money in the account to hold the position, you can continue to short sell.
Without the ability to short sell, the market can't even function effectively.
Convertible/Risk arbitrage people cannot do their job wihout short selling. The risk-free spread is there for the taking, but you can't take it.
Options market makers cannot hedge their PUT writes without short selling.
This is what I envision:
We'll see a massive short covering rally caused by a dry up in volumes by next week.
Option traders will stop trading as they cannot properly hedge their postions, as will all risk arbitrage, debenture, derivative and ETF traders. Traders of all financial products will not trade if they cannot hedge their positions.
Liquidity will dry up and volatility will increase drastically, which is exactly what the SEC wants to avoid.
The USA has decided to follow their Russian and Pakistani comrades in artificially controlling the market.
It's over fellas.
We've killed the banks. Now we'll kill the hedge funds and the options houses.