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Special Report
Europe’s Shorts-Sightedness
Yesterday’s decision by European authorities will likely further damage markets in the U.S. as well.
This week, troubles in Europe may have played as much of a role in the U.S. stock market carnage and volatility as the downgrade of U.S debt. A just-announced decision by European authorities will likely damage markets there and in the U.S. even further by trying to “fix” them.
The European Securities and Markets Authority, which coordinates financial market policies for the European Union, declared a ban Thursday evening on short-selling certain stocks in France, Belgium, Italy and Spain. For an amount of time not specified in the release, no negative bet will be allowed on the prospects of these stocks.
As with proposals to jail executives at Standard & Poor’s, the EU’s action in this case is properly called “killing the messenger.” And if a temporary American ban on short-selling in the panic of 2008 is any guide, it will like make market volatility worse by suppressing vitally needed market signals. Most economists — both liberal and conservative — see shorts as a valuable counterweight to the market euphoria that creates bubbles and to the market panic that results in busts.
The main form of short-selling is borrowing shares from a broker and buying them back at a later date. If the stock price drops, short-sellers pocket the profits. But if the price keeps going up, shorts eventually have to “cover” and pay the difference.
As noted in Michael Lewis’s best-seller The Big Short, which chronicled the stories of those who bet against housing before the mortgage bubble burst, short-sellers can reap great rewards if they’re right. They can also be at great risk if they’re wrong. But win or lose, they send very important market signals about both individual companies and the economy as a whole.
As liberal New Yorker writer James Surowiecki observed in his book The Wisdom of Crowds, if the price of a stock “represents a weighted average of investors’ judgments, it’s more likely to be accurate if those investors aren’t all cut from the same cloth.” A market with few shorts, he argued, increases vastly the chances that if a price “gets out of whack, it will really get out of whack.”
And as John Tamny, free-market economist and editor of RealClearMarkets.com, has written in Forbes, “Short-sellers provide information, or what some call ‘feedback,’ to investors, (and) when their activities are made illegal, information that is necessary to correctly price securities is lost.”
We know all that, say the European officials as did the American regulators in 2008, but this an emergency! In a panic, they argue, short-sellers add fuel to the inferno.
But in fact, during panic selling, short-sellers are about the only ones carrying an extinguisher. Because they have to buy stock to take their profits, they are the ones who call a bottom in the market as well as a top. As Tamny observed, “while short-sellers bristle as their sales take stock prices down, they’re the ultimate savior of those same firms later on in the game.” In a panic, without bears, there are only neutered bulls stampeding for the exits.
A consensus is emerging that the U.S. short-selling ban of 2008 actually made the stock market fall further than it otherwise would have. As the New York Times noted Thursday in reporting on the European ban, “the ban on short-selling in 2008 has been widely criticized and blamed for driving investors out of the market altogether, further hurting stock prices.”
Going back further, short-selling bans worsened the Great Depression in the early 1930s. As free-market economist Benjamin Anderson wrote in his classic Economics and the Public Welfare, the series of bans in 1931 and 1932 resulted in share price declines that “were more extreme,” followed by “rallies [that] were far feebler than would otherwise have been the case.” Since today markets are more interconnected than ever and many American investors have European stock — indeed many European firms trade on our stock exchanges — the fact that a shorting ban may make prices eventually fall further would hurt American portfolios as well.
The real question policy makers should ask about shorts is why aren’t there more of them. If more investors had been like the heroes of The Big Short, the mortgage bubble would not likely have accelerated as fast as it did, because of the check shorts provide on irrational exuberance. Rules for mutual funds and exchange-traded funds should be liberalized so that retail investors can enjoy the same opportunities for shorting in their portfolios as the wealthy investors served by hedge funds now enjoy.
In examining the balance sheets of companies and of countries, suppressing the messenger doesn’t work. If Europe says its corporations are so fragile that they need to be protected from any negative feedback, why should anyone invest in them or loan them money in the first place?
About the Author
John Berlau is Senior Fellow for Finance and Access to Capital at the Competitive Enterprise Institute and blogs at OpenMarket.org.
Letter to the Editor View all comments (23) | Leave a comment
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chuck| 8.12.11 @ 7:34AM
Short sellers are hated because they profit when everyone else is losing. Kind of like playing the Don't Pass line at craps. But short sellers play an important role. They are the buyers when everyone is selling. They keep a stock from falling further than is necessary. Remember, for every sale, there must be a seller and a buyer. In a panic situation, without buyers the price tumbles until there is a buyer.
JP| 8.12.11 @ 8:54AM
Short sellers sniffed out Enron when everyone else wanted in on thier stock.
massmile | 8.12.11 @ 1:06PM
You're a Peons tend to be children pretending to be adults. Worthless.I am a 26 years old nurse, young and beautiful. Now I am seeking an older gentle man who can give me real love , so i got a username Annababe2011 on---a'ge'l'ov'e'r. C óM---it is the first and best club for y'ounger women and older men, or older women and younger men,to int'eract with each other. Maybe you wanna ch'eck it out or tell your friends.
Occam's Tool| 8.12.11 @ 2:29PM
Wow, a 26 year old beautiful nurse, repeating my words. Wow. But what does ch'eck mean?
Couldn't be SPAM, now? Damn.
Groad| 8.12.11 @ 8:49PM
A Ho' don'cha 'No.
Michael Tomlinson| 8.12.11 @ 7:36AM
The real problem for the American stock market and economy is Barack Obama and the Democrat party.
oldfart| 8.12.11 @ 8:12AM
Let's see what the EU is doing - new carbon tax on airplanes - cost of freight and travel will go up - ban on short selling - taking buyers out of the market - creating an on-going under class by putting about 1/3 of the population on public assistance (you don't have to work - just go clubbing and stay high on the drug of your choice). Are these people really that STUPID?
Groad| 8.12.11 @ 8:51PM
If it walks like duck, quacks like a duck.....
Southern_Comment| 8.12.11 @ 8:17AM
Yes
A. C. Santore| 8.12.11 @ 8:32AM
I read these articles about the stock market with mild amusement at best, and no sense of pity for anyone who "loses" in the market..
The dirty little secret about the stock market is that one doesn't "invest" in stocks on the stock market - one "gambles." And it makes no difference whether one "bets" that the price will go up or down. The goal is easy money for doing nothing.
The only real investors are those who buy shares directly from the issuing company, which then uses the money to create or expand their business, thereby creating jobs and wealth, and then paying a real return on a real investment.
When someone other than the issuing company sells stock to make a "profit," the issuing company does not get a dime of it.
It reminds me of the island in "The Admirable Creighton" by J. M. Barrie, where everyone made a precarious living by taking in each others laundry.
wukong| 8.12.11 @ 11:51AM
Would you like to explain how some one is to recover the proceeds of that initial investment? How is any one to place a value on the corporation? Everyone has different risk tolerances, how do you differentiate persons who are willing to take risks with a start up as opposed to one who wishes for income thru dividend in a stable company?
Paul Nelson| 8.12.11 @ 12:40PM
I assume that the value of common stock that cannot be sold to someone else is discounted present value of the dividend stream. This would then mean that start-up companies that truly NEED to sell stock to raise capital but have no income would be unable to sell that stock. Further, in order to be able to price a stock one has to be able to guess when a dividend will be declared and what the rate of interest, or more to the point what the rate of inflation, will be. Obviously the current rate of interest is well below the rate of inflation which is being systematically underestimated.
JimH| 8.12.11 @ 8:53AM
Short selling can involve considerable risk. A share value can only drop to zero. It ca go up indefinitely.
Ryan| 8.12.11 @ 8:55AM
If there is anything that needs to be done in the market, it's probably banning computer-driven automatic trading. Human beings should push the buy and sell buttons, not computers.
It's monopolistic and anti-free market, and hurts particularly small investors.
Occam's Tool| 8.12.11 @ 12:41PM
You're a Peons tend to be children pretending to be adults. Worthless.
Michele San Pietro| 8.12.11 @ 2:38PM
Short-sightedness is an euphemism. Europeans have been practicting terroristm against Americans for decades. This must stop once and for all!
POST American| 8.12.11 @ 11:16PM
"When the Big Boys want something to
happen --they MAKE it happen."
-ALAN WATT
(essential online coverage)
They REALLY do.
NOTICE how this latest, no doubt again,
capstone Freemason provocateured England
rioting receives NO background investigation
----and the most routine narrative frame up.
ALLLL this just weeks after that other, 'Break Their Hearts'
Masonic-Templar wannabe in Norway.
"Christian Terrorist? --the world debates"
-Yahoo News
-----------------------------RRRRRIGHT
AGAIN kiddies ----these are 11th hour times.
DO call out and throw out the Freemasons,
'Clergy Response' fronts and 'Council of Churches'
stooges from your church establishment ---that
is if you're at all serious about your church, your
country, or your very soul...
Mike| 8.13.11 @ 5:41AM
Maybe you wanna ch'eck it out or tell your friends.
http://www.summer-products.com
http://www.jerseys-hats-store.com
Nice| 8.13.11 @ 5:43AM
The real problem for the American stock market and economy is Barack Obama and the Democrat party.
http://www.ainibag.com
http://www.honey-gifts.com
Marc Jeric| 8.13.11 @ 12:02PM
In communist countries there are no stock markets, and therefore no short-selling, no retirement funds, no traders, only one company (Communist Party) - in other words they are heaven on earth. Mullah Obama is working hard to brings those blessings.
Timothy L. Pennell| 8.14.11 @ 7:44AM
The "Problem" with Europe, is that there is no longer a SOVIET UNION. No Soviet Union, means: No need for a Cohesive MILITARY. Europe has NO MILITARY. Therefore, no sense of NATIONAL PRIDE. Nothing to act as GLUE.
The Soviets provided a specific THREAT. A COMMON enemy. A MISSION of Self Preservation, that Bonded the European Nations, like the EURO never will.
And, it wasn't just the THREAT. It was the DISCIPLINE, that a MILITARY brings to it's Forces. A Comradery. A sense of Purposefulness. NATIONAL PRIDE.
Does anyone see ANY OF THIS, in Europe, today? Is there any PURPOSE, for Europe?
America is STILL the Defender of FREEDOM, in the world. America has STILL got her Mission. She is STILL the World's BEST HOPE.
Europe is SOFT and WEAK. Her people are SOFT and WEAK. They have no great Quests, for their people. The people are DENDENT on a Central Government for EVERYTHING. For their MEDICINE. For their HOUSING. For their RETIREMENT. For their TRANSPORTATION. They have lost their Freedom Of Speech. They are brought up before the Magistrate, for speaking their minds. It's called: HATE SPEECH. They sit around all day, doing what one does, in a Collective. Each performing his, or her's TASK, as a COG, in the Government Machine.
They no longer have the SOVIETS, to push them in to decisive action.
They have BECOME the Soviets, in every way. Everyone has become the same. They all have NOTHING.
Soon coming to an OBAMA run Country, near YOU.
POST American| 8.14.11 @ 10:20PM
"We are using MASSIVE third world
immigration to DESTROY British culture
beyond repair, once and for all ---FOREVER."
-TONY BLAIR
Fmr PM/ Globalist/ Cultural EUGENIST
and ---future EU President?
(Daily Mail interview)
AS Britain burns.
AND AS America now borders a Globalist collapsed Mexico with a yearly death toll of dope violence that now exceeds the Viet Nam War.
MEANWHILE, 30 MILLION loitering and genetically
disenfranchised, surplus males
are waiting in Globalist created,
US taxpayer funded and enabled ---RED China.
Waiting for something to do----
" ---Did you just hear me? ---THIS IS TREASON."
-ALEX JONES
('It's the Bankers or US' on youtube)
---------------------IT REALLY IS-----------------------
------------------------REALLY---------------------------