Thursday, October 09, 2008

Regulators Short on Common Sense

A few weeks back, the Feds placed a temporary freeze on short orders for a select group of financial equities. The short term order expired between the trading session on 10/8 and 10/9/2008. Not surprisingly both days saw massive drops in the market.

The stock market is driven by anticipation. It was apparent to all that the end of the short ban would result in record shorting activity. Before the end of the expiration, people were hesitant to buy and quick to sell. The day after the ban expiration was another massacre. Why would you buy when you knew that shorts were going to artificially inflate the float on the market by several hundred million shares?

The defenders of shorting are pointing to the fact that investors behaved like lemmings in light of the short ban as proof that shorting is good.

My observation is that the lemming cliff dive taken by investors on the last days of the shorting ban shows that attempts to regulate shorting will have unanticipated consequences.

The very fact that several days of trading were dominated by the anticipation and manifestation of the end of the short ban shows that shorting has the affect of diverting attention from the underlying value of securities. Short selling and all the regulations around the activity around the anti-market activity draws attentional away from the actual value of securities and into destructive day trading and power games.

To me the events are further evidence than we can never have a happy middle ground where shorts are regulated. We will either have a market with completely unrestricted shorting where short sellers routinely short multiples of the float of securities, or shorting must be disallowed altogether.

The point I want to drive is that shorts are an artificial creation designed to regulate stocks. Selling something that belongs to someone else is the ultimate violation or property rights. Short selling is a regulatory tool that is antithetical to the free market.

Elimating short selling is not the matter of adding regulations. It is the matter of removing regulations that were designed by elitists who believed that the market was incapable of pricing equities on its own. The design of short selling is based on the premise that elitist brokers had perfect knowledge and that they would altruistically short overpriced stock.

The temerity of this assumption is astounding.

The short sell is the creation of regulations. Like most such regulations, history has shown that shorting have done substantially more harm than good.

Short selling is the creation of regulators.

Short selling is the creation of regulators.

Short selling is the creation of regulators.

Short selling is the creation of regulators.

Short selling is the creation of regulators.

Get the point?

Banning short selling is not a regulation. It is the removal of one of the most idiotic regulations conceived by anti-market regulators. The regulation has done nothing but transfer massive amounts of equity from productive segments of the economy into the hands of traders.

Shorting was designed by regulators as a tool for regulating the market. It exists so that brokerages can increase the float of a the market if they feel an equity is overpriced.

Like most regulations it has failed. The regulatory tool of shorting has proven itself to add to market volatility. Shorting makes it exponentially more difficult to value assets.

We can file the temporary short ban as another fiasco in the long line of fiascos created by this absurd regulator tool--the short sell.


Obi wan liberali said...

shortshelling isn't about regulators, but about financial institutions speculating about future values of certain securites. If they guess wrong they are toast, and they know it. This about weak corporate governance and far less about regulation.

y-intercept said...

Shorting is not just speculation. Shorting increases the number of virtual shares on the market. After a short, there are two people holding the same sheet of paper thinking that they are invested in a company.

When you talk to regulators and brokers they put this magic ability to regulate the number of shares as the primary benefit of short sells.