A very short post

I've blogged a lot about the pernicious practice of short selling in financial markets over the years. It's impossible for me not to feel vindicated now that hedge funds are getting handed their heads by a group of retail investors co-ordinating their activities through Reddit. It will end in tears, for the Redditors as well as the hedgies, but it might all be worthwhile if financial regulators finally wise up to the fact that this entire practice is unnecessary and harmful. Here are a couple of extracts from past postings on the subject.

First, one from a post called "Get Shorty" from 24 July 2011, at the height of the Greek debt crisis:

The key weapon in doing this will, as usual, be short selling, especially by hedge funds. Financial institutions always defend this practice, arguing that it provides a mechanism for identifying underlying problems quickly and bringing them to a head. As I've suggested in these pages in the past, this is akin to claiming that the school sneak, the kid who rats out his schoolmates for smoking behind the bike sheds, is a major contributor to school discipline. It's not as if the hedgies can claim any special expertise that has allowed them to figure out there is too much sovereign debt in some Eurozone countries. Everybody knows that. The bizarre part is that nobody seems seriously inclined to curb the short sellers, even though the costs, if they succeed in bringing down another debtor, will be borne by the same taxpayers that picked up the tab last time.

Michael Lewis's "The Big Short" painted a knockabout picture of a bunch of geeky oddballs making money by shorting asset backed bonds. However, the role of short selling in the runup to the financial crisis was pernicious. The most egregious example was provided by Goldman Sachs, who reportedly allowed a known short-seller to select ropey assets as collateral for one of their ABS deals, ensuring profits for the short seller as soon as the deal came to market. There may be no scope for that sort of skulduggery with Spanish or Italian bonds, but there's no reason to suppose that the short sellers will be any more scrupulous in their dealings.

The irony is that the hedge funds doing the short selling generally carry far more leverage than Italy or Spain do. Neither of those countries is in anything like as much trouble as Greece. The hedgies are unapologetic about trying to bring the sovereign debtors to their knees. It's long past time for regulators to return the favour.

And this is from a post just a couple of weeks later, on 14 August 2011, after a particularly wild week in global equity markets.

Investors have a perfect right to fall in and out of love with stocks. If you decide you don't like a particular stock that you own, you can try to sell it to someone else who sees things differently; conflicting opinions of value are the basis of every trade. But short-selling allows you to try to make profits out of something you don't even own, at the expense of legitimate sellers and innocent bystanders. Contrary to the claims of its apologists, there's no way that this activity adds anything to the efficient functioning of markets. When it's combined with rumour-mongering, as seems to have been the case with French bank shares this past week, it crosses the boundaries of the merely under-handed and becomes outright malevolent and immoral.

One of the business news networks concocted a graphic this week that purported to show that short selling bans don't even work. Using data for US stocks when such a ban was imposed at the height of the financial crisis in 2008, it appeared to show that over the following two weeks, the overall market was down 18% (if memory serves), while financials, covered by the short selling ban, fell by 23%.

It is, of course, not possible to test a counterfactual, but recall that at the time of the Lehman Brothers failure, there was a wholesale flight from financial stocks. Nobody attempted to stop those who owned bank shares from selling them, so it's not surprising that they fell more than the broader market. But it's surely reasonable to posit that the ban on short selling prevented gleeful speculators from making the carnage immeasurably worse, which is exactly what it was intended to do.

Almost a decade on, I'm quite happy to stand by those statements.