In Defense of Short-Selling

The Washington Post reports that federal regulators are slowing down in the zeal to regulate short-selling out of existence.

The Securities and Exchange Commission on Monday delayed a decision on whether to put in place new measures to limit short-selling stocks, underscoring the difficulty of pursuing new financial regulations.

The SEC moved swiftly in April to propose new curbs after executives, investors and lawmakers complained that short-selling helped crater the stocks of banks and other firms at the height of the financial crisis. Short-selling involves a bet that a company's shares will fall, and abundant short-selling can push down the price of a company's shares. (more)

Short selling is as important to a properly functioning market as betting on a stock's success. Without the ability to invest against a position or a company, investors would be faced with only the ability to gain when a company's stock rises. This eliminates huge incentives to root out inefficient companies that are wasting resources. Critics complain that short-sellers burst the bubble on cratering stocks, but they should blame the bubble, not the pin.

Risking your own money on the presumption that a company is performing poorly is no more greedy or speculative than buying a stock thinking it will appreciate. We need both upward and downward pressure on securities to ensure they are properly valued; that stock prices reflect the actual value of the companies they represent.

Eliminating short-selling, or regulating it to the point of extinction, would not prevent future bubbles from bursting. In fact, it would fuel even bigger bubbles in the future, as investors would be left with fewer ways to shed overvalued stocks before the bubble burst entirely.