Saturday, September 20, 2008

Changing the Messy Shorts

I guess it is now official. The bailout program passed by Congress failed. We know that it has officially failed because Congress is scrambling to pass another massive bailout.

I am looking at the financial market. The one thing that stands out in this market is a historic high in the number of shorts.

Shorts were created as a regulatory tool (See Free Markets Don't Wear Shorts). The idea is that shorts would be used as a tool to cap peaks by allowing an artificial increase in the float of a stock. The shorts would provide liquidity as shorters bought back in times of crisis.

What's happened in 2008 is that shorters increased their short positions during the economic downturn magnifying the current liquidity crisis. Shorters are not naturally inclined to buy back, and they are not providing liquity as expected. Instead, they are expanding their positions.

Since shorts were designed as a regulatory tool, I contend that regulators should use their power to regulate shorts before another dip into the taxpayers' pockets.

I contend that the SEC should expand its ban on shorts (essentially, the Feds should ban all short selling for the foreseeable future while aggressively investigating charges of criminal conspiracy in short selling). In 2009, the next Congress would take up the issue of whether or not to allow shorting.

The justification for shorting is that shorting provides a tool for regulating the market. Here is the catch, shorting only has value if the shorting is actively controlled by regulators. As the 2008 liquidity crisis proved, unregulated shorting simply increases the hardships of economic dips by artificially increasing the float of stock as the market falls.

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