May 4, 2009
I do not understand the need for allowing stock short transactions of any kind.
Premise: Purpose of the stock market is to provide capital for company growth, and allow investors an opportunity to benefit from that growth. This fundamental idea is simple and appears to provide healthy growth potential for all entities involved.
Short selling is betting against a company. It is not investing in, but against.
The temptation and opportunity to manipulate a companies stock through shorting seems much greater than with standard investing.
To prevent manipulation via shorting and especially naked shorting, the SEC has to implement complex rules, and tightly monitor many transactions to catch violations. Even if violations are caught, irreversible damage could have already occurred. I suspect clever people can find ways around monitoring. If shorting is not allowed, maximum simplification of regulation is accomplished.
The lack of liquidity argument for allowing short selling claims that short selling provides shares available for purchase when there otherwise might not be any. This implies that there should always be shares available for sale. Why? If there are no shares for sale at a given (or any) price, I don't see why shares need to be artificially created by borrowing some from a broker. And just where did the broker get shares that are supposedly unavailable. If shares are not available, then they must be considered valuable, and prices should go up.
Another argument for shorting is that it forces quick adjustment (efficiency) of a stock value if the current price is inflated. Why is this necessary? If a stock price is considered overvalued, then there's likely to be more sellers than buyers and the price will fall. If a company has negative financial or other news, the price will fall. With so many analyst and fast news, it unlikely that negative information will stay hidden long. Those investors who buy or hold a stock that does not have positive news flow are taking a higher risk and are more likely to have losses. I think efficient price adjustment will be present without short transactions.
All these complex transactions with names like shorting, naked shorting, hedging, leveraging, options, futures, etc. seem to be ways to play the market that, at least initially, were above the average investor. They are a way for mostly large, financial firms to gain advantage, and have little to do with helping good businesses grow. We should ask if these special transactions are necessary for a healthy market, or are they serving some other purpose. To many investors, todays stock market appears to be a giant, dangerous, shell game where inside players are moving special financial instruments they created for themselves.
If you want transparency and regulation that's simple, cheap, and effective, then keep the transactions simple. This may be especially important in an environment where programmed transactions can occur very fast. We should be able to only buy and sell. Maybe borrow from your broker (buy on margin) if you want to take more risk, but in this case it looks like the broker must be required to hold the shares you bought.
This is off topic, but credit default swaps are an example of how dangerous the markets can get if allowed to create transactions and instruments as they wish. Complexity can be dangerous in many endeavors.
Making large wholesale changes to complex systems is risky. I suggest that such changes be done in phases to minimize unanticipated neqative consequences.