macroblog

About


The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.


« The growing case for a jobless recovery | Main | What is systemic risk, anyway? »

October 28, 2009


Selling stocks short: Ever controversial

Selling securities short has been a controversial practice as long as financial markets have existed, and the recent financial crisis brought short selling to the fore yet again. In the last week, a bill to impose new restrictions on short selling was introduced.

And earlier this month in its inaugural conference, the Atlanta Fed's new Center for Financial Innovation and Stability (CenFIS) provided a forum for discussing the topic of short selling.

Why does short selling have such a bad reputation? Financial economists generally have a positive view of short selling because short sellers take positions with risk of loss based on their view of a firm's prospects. Some others, though, generally do not take such a benign view of short selling.

Attitudes toward short selling reflect views about speculation. As Stuart Banner notes, a common historical view was that "[s]peculation was both productive and wasteful; it satisfied an evident demand, but its practitioners added no value to the community" (Banner 1998, p. 23). Banning short selling also has a long history. In the United Kingdom, "An act to prevent the infamous practice of stock-jobbing" was passed in 1734, an effort that attempted to ban short selling and was not repealed until 1860. In the United States, contracts to sell stock not owned at the time of sale were unenforceable in New York courts from 1792 to 1858.

Possibly short selling has a bad reputation partly because of its association with "bear raids." A bear raid is a set of trades in which a stock is sold short at a high price, negative rumors are spread to cause the price to fall, and then the short sales are covered by purchasing the stock at the lower price. Some discussions of bear raids suggest that buying stock on the way back up is a way of adding to the raider's profits from manipulating the stock price.

Bear raids are similar to speculators' manipulation of foreign exchange (Friedman 1953). Both are based on attempts to move a financial market price independent of any underlying development. Successful instances of bear raids and exchange-rate manipulation are similar in another way: They are far less frequent than complaints about them.

Selling securities short has a long and controversial history. While it's not clear whether proposed legislation on short selling will be enacted, it's a good bet that short selling's risks and benefits will be debated for quite some time.

By Gerald P. Dwyer, director of the Atlanta Fed's Center for Financial Innovation and Stability

References

Banner, Stuart. 1998. Anglo-American Securities Regulation. Cambridge: Cambridge University Press.

Friedman, Milton. 1953. "The Case for Flexible Exchange Rates." In Essays in Positive Economics, pp. 157-203. Chicago: University of Chicago Press.

October 28, 2009 in Capital Markets | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef0120a6840171970c

Listed below are links to blogs that reference Selling stocks short: Ever controversial:

Comments

Here is the problems with short selling. First, because of the idiosyncrasies involved with the reporting and borrowing of stock, players are able to short more stock than is actually available to short. Matt Taibbi has a good article on this in Rolling Stone of all places.

Secondly, the uptick rule gave good discipline to short sellers, since you were only able to short when someone was doing some buying. No uptick rule means that risk profiles are different. They favor the short sellers, since they can literally short at will. Because of the aforementioned stock reporting rules, they are in fact able to conduct bear raids on stocks.

Because the rules of the SEC are drawn to favor the big banks, there is no way for a company, or a group of shareholders to stop it. The short sale might start in a dark pool of liquidity, away from where the rest of the market can even see it. It might start on an order that has been internalized-and the price/volume isn't reported to the market for hours.

I am not against short selling. I am for it-but with correct restrictions. Bring back the uptick rule. Don't allow excess shares to be shorted.

Secondly, change the market structure to make the playing field level. Outlaw dark pools of liquidity, payment for order flow, and internalization of orders, and ban dual trading. Make every order be competitively bid on an organized exchange in which all market participants can see price/volume.

Shorting would provide an economic benefit to the marketplace under those conditions.

Posted by: Jeff Carter | October 30, 2009 at 01:16 PM

Short selling is a positive thing for markets that is best appreciated in markets where it is absent. It helps to moderate - I stress moderate, not stop - euphoric markets and helps to manage falling markets - again, I stress manage, not stop. In falling markets without shorts there can be literally no buyer. In markets with shorts as the market falls, shorts tend to cover, providing liquidity to sellers. Some may find this argument tough to swallow given the vicious markets of the past year, but looking at even more aggressive falls and gaps in EM markets without shorts suggests the US markets would have had an even rougher ride w/o shorts.

None of the above is to argue that the practice of short selling should not be regulated to prevent market abuse...in the same vein as the need to regulate longs that aim to abuse markets, for example by trying to corner a security. My point is to avoid throwing the baby out with the bathwater.

Posted by: rfarris | November 01, 2009 at 04:57 AM

The U.S. necessarily has regulated capitalism, because of monopolies, etc., etc.

Savings used as financial transactions to sell stocks short doesn't add to the goods and services produced, it subtracts from the potential of new goods & services produced.

That should be reason enough to outlaw wasted speculation.

Posted by: flow5 | November 01, 2009 at 09:12 PM

Just wondering, why was Stock-jobbing allowed again?

Did they have a good reason, like see something amiss in the system? Or was it just politics?

Posted by: FormerSSResident | November 02, 2009 at 03:25 PM

Stock jobbing is now called High Frequency Trading, or day trading.
It's allowed, and it would be more expensive if they outlawed payment for order flow.

Posted by: jeff | November 03, 2009 at 04:33 PM

Short-selling also can help investors moderate the overall risk in their portfolios. Certainly, an investor with a long-short portfolio last year would have been better-positioned than one with a long-only portfolio. Piotroski (2000) showed the impressive returns that can be generated by a long-short portfolio based on value investing fundamentals (such as financial strength versus financial distress).

Posted by: David Pinsen | November 04, 2009 at 11:04 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

Google Search



Recent Posts


November 2014


Sun Mon Tue Wed Thu Fri Sat
            1
2 3 4 5 6 7 8
9 10 11 12 13 14 15
16 17 18 19 20 21 22
23 24 25 26 27 28 29
30            

Archives


Categories


Powered by TypePad