Bubbles, Fraud, Government and Short Sellers

by Chidem Kurdas

The new issue of the Freeman contains an excellent article on short selling by Warren C. Gibson.  This investment method – selling borrowed stocks in the expectation of  buying them later at lower prices – is always controversial. Regulators temporarily banned it for financial stocks during the credit crisis of 2008 and now look to place other restrictions, about which Mr. Gibson provides a lucid discussion.

Short sellers seek to identify companies that are over-valued. Studies indicate that they tend to be correct in their analysis of businesses and the stocks they pick tend to go down. Many corporate frauds were first uncovered by these traders. James Chanos, probably the best known short-seller, figured out Enron a long time before any regulator did.

Short selling can limit bubbles in asset prices. In the past 15 years, we’ve had a stock bubble, real estate bubble and credit bubble. Given this dangerous bubble-proneness, short selling is a particularly valuable market mechanism. Regulators pay lip service to its benefits, but have proposed rules to inhibit this type of trading.

Why they do so says a lot about how the government operates. It also says a lot about how political action skews markets. Continue reading