InvestorQ : Will the US consider banning of short selling of publicly traded equities?
Shreya Mashelkar made post

Will the US consider banning of short selling of publicly traded equities?

riya Ranade answered.
6 months ago
I don’t think this is as bad as it is made out to be. What does short selling do? It exploits an expected drop in the share price. The same as a put option. I believe short sales is a technique in trading on the stock market where, if done correctly will yield even in a down market. As long as market trades are done within the legal framework, it is best left to its devices. Government interference in a nearly free-market system will lead to an artificial environment and create chaos and confusion. The strongest argument against a ban on short selling is that it interferes with natural price discovery, and reduces liquidity. That apart, there is no credible evidence that curbs on short-selling in the past have helped stabilize stock prices.
In September 2008, the US Securities and Exchange Commission (SEC) had temporarily banned short sales in nearly 1,000 financial stocks to halt the free fall in prices. Stock prices rebounded briefly but then continued to decline for the rest of the period when the short sale ban was in effect. Some months later, SEC Chairman Christopher Cox expressed regret at the decision to ban short selling.
For all the apprehension that shorts evoke in the minds of the general public, they do perform positive actions. For example, during the panic crash in March, the only thing stopping the freefall in prices was buying. Who was doing that buying? A big chunk of that was short-sellers who have to buy back in to close out trades, and secure their profits. If short-sellers didn’t exist, the falls during a panic would be even worse than they are now.
They also provide very good cues to companies who are not doing the right thing. It’s often short-sellers who forensically study and investigate companies and unearth things that the company is doing wrong and trying to cover-up. They help balance markets against the tendency of bulls to inflate bubbles with excessive credit-fueled leverage. If you allow bulls to leverage but not bears, bubbles will typically inflate longer before they pop. The root of financial instability is not shorting per se, but credit expansion and contraction. Shorts are primarily a symptom of the expectation that credit conditions will soon reverse. Banning assets purchased with credit would be much more consequential than banning shorts, and harder still to enforce.
What critics maybe are concerned about is naked short sales, meaning sales without owning any security in the first place. It makes sense to restrict naked short selling under certain market conditions because such sales have the power to set off a vicious cycle wherein falling prices trigger panic and prompts more people to dump their holdings, in turn pushing prices further down. It is possible to monitor naked short sales in the cash market, as the regulator just has to ensure that every sell trade is backed by the delivery of the shares. In other words, a seller cannot square off his sell position during the day and has to deliver the shares.