“(MoneyWatch) Short selling has received its share of blame for market crises, even being targeted in 2008 as a reason for financial stocks to continue plummeting. However, a new study suggests that not only is short selling not a cause of market problems, but is even necessary for markets to function correctly.
Short selling is the practice of selling securities (or other financial instruments) with the intention of subsequently repurchasing them at a lower price. To go short, the seller pays the holder a fee to “borrow” the securities and sells them. The hope is that the securities drop in price, allowing the seller to repurchase them for less than they sold them. They return the securities and pocket the difference. (Of course, they owe the difference if the securities rise in price, and the potential losses they face are unlimited.)
Because short selling can drive down the price of shares of that security, it has historically been a target for criticism. For example, short sellers were blamed for the Wall Street Crash of 1929. That led to regulations governing short selling being implemented, including a ban on selling short after a downtick in price. This was known as the “uptick rule” and was in effect until July 3, 2007, when it was removed by the SEC.
Short selling in 2008
The financial crises of 2008 once again brought short sellers into the cross hairs of Congress and the financial media. Critics blamed them for creating instability in the stock market, and for creating downward pressure on financial stocks in particular. In response, a number of countries introduced restrictive regulations on short-selling in 2008 and 2009. For example, in September 2008, the SEC banned short sales (primarily in financial stocks) to protect companies under siege in the stock market. That ban expired several weeks later as regulators determined the ban wasn’t effective in stabilizing the price of stocks. Temporary short-selling bans were also introduced in the U.K., Germany, France, Italy and other European countries in 2008.
Short selling evidence….”
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