Dollars and Jens
Friday, July 18, 2008
naked shortselling
The SEC a few days ago issued a new rule prohibiting naked short-selling of the stocks of certain financial companies — if you want to sell the shares, you have to actually have them available, whether owned or borrowed from a willing lender — and I kind of think the Wall Street Journal is right about this; it's probably relatively harmless as far as these sorts of things go.
This is also a question best left to private contracts, as the short seller who doesn't deliver the promised shares can be treated like anyone who reneges on a deal. Still, if the SEC is going to uphold the principle that someone selling an asset should definitely be able to deliver that asset to the buyer, well, we've heard crazier ideas.
I've been thinking for a couple years now that one of the responses government should make to apparent bubbles is a bit more vigilance in terms of enforcing regulations, preventing frauds and the like, which become more common as the bubble goes along. This enforcement may tend to be a bit one-sided — but, then, so (typically) is the increased opportunity for fraud and the like — and may slow down price adjustments, which would be a negative if the regulators incorrectly target a price-change that is more sustainable, but it shouldn't prevent the market from getting there eventually — it might just take a bit longer to get there, if that's really where it should be headed. The direct monitoring of potential fraudulent activity is the primary form I'd expect this response to take, but regulations limiting potential counterparty risks on securities exchanges, and even somewhat tighter margin limits (where the perpetrator's own broker, not every participant on the exchange, is subjected to the credit risk) seem like reasonable tools. As the Journal says, limiting naked short selling isn't nuts, and isn't likely to interfere with the market eventually reaching its equilibrium, but I would add that it might reduce the potential for some chaos (failures to deliver, etc.) as we get there, and as such might even be a good thing.

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