Short shrift

Chancellor Merkel's decision to ban "naked" short-selling in Germany has come under attack from the usual quarters. Traders have ridiculed the measure, pointing out that there is nothing to stop them shorting German debt out of London or Paris or elsewhere. The right-wing press in the UK has also piled in; see, for example, Tracy Corrigan's May 19 blog posting on the Telegraph website. Tracy excoriates Merkel's action on the grounds that: it won't work; the French are upset; EU officials are upset; and anyway there is no evidence that short-selling has anything to do with the problems in Greece.

While much of this is true, there is a case for restricting short-selling, especially of the so-called "naked" variety. In fuddy-duddy, old fashioned short selling, the seller had to borrow the securities that were to be sold short. This never made much sense to me -- why would I lend a stock to a short seller if I knew his plan was to try to pulverise the value of my asset? -- but at least it limited the activity. With naked short-selling, the seller doesn't have to borrow the securities. This makes it riskier (because it may be impossible to get hold of the stock when the time comes to cover the short) but also more lucrative (because borrowing the securities costs money). The US already bans naked short-selling, and those who can remember back as far as the start of the credit crisis will recall that the US, UK and other jurisdictions moved quickly to ban all types of short-selling in an attempt to stem the decline in markets. In fact, this happens in just about every financial crisis, which is an odd thing to happen if short-selling is such a good thing.

According to Ms Corrigan and other defenders of shorting, short-selling is a useful tool in markets because it helps to reduce the likelihood of speculative bubbles. Oh yeah? I struggle to recall any headlines over the past decade or so on the lines of "Short sellers prevent tech stock bubble", or "Shorts head off credit crunch", but there have been countless stories of short sellers ganging up on perceived weaker credits and driving them into the ground. Although it's true that Greece's problems, and those of the banks that have loaned money to Greece, are entirely of their own making, it's hard to see any rationale for allowing short sellers to wade in and make money by impeding efforts to clean up the mess.

Some time ago (September 2008) I wrote that short sellers were like the kid in school who ratted out his fellow students when they did something naughty. Nobody likes that kid, and very few people like short sellers, maybe aside from Tracy Corrigan. The fact that this kind of thing is tolerated illustrates the extent to which the financial sector has managed to place itself on a different moral and even legal footing from other businesses: as master, instead of servant. There's nothing new about this, of course: the Medicis were quite convinced that it was in their remit to appoint Popes. Even though Frau Merkel's actions looked panicky and may prove ineffective, it would be good to see more politicians standing up to today's Medicis.