Short-selling seems kind of sinister. After all, it allows an investor to make money when a stock price falls.
In fact, throughout history, governments have periodically banned short-selling. Napoleon outlawed it in his Napoleonic Code. And the U.S. imposed its first ban in 1812 (it was certainly a bad year).
So in light of the recent market plunge across the globe, it’s a good bet we’ll see some bans like the one recently announced by both Greece and South Korea. Greece’s ban – which starts on Tuesday – could last for two months, though it could be lifted sooner. South Korea imposed a three-month ban.
Basically, these are ridiculous moves. Hey, why not also ban selling as well? Or perhaps just mandate that prices not fall below a certain point?
There is a reason we have markets: they are highly efficient in allocating capital. Unfortunately, Greece’s performance has offered few reasons for investors to get optimistic, so its leaders decided to make adjustments intended to stabilize the market. The market regulator in South Korea, meanwhile, is worried about diminishing global demand for the country’s exports.
The thing is, short-selling is necessary for any modern stock exchange. It allows for better management of order flow for traders. Short selling is also a great tool to hedge positions. What’s more, investors always find ways to work around a ban. For example, they can create derivatives or synthetic securities.
No doubt, Greece is still a small factor in the world economy (and it seems to be getting smaller), although South Korea, Asia’s fourth-largest economy, is a significantly bigger force. But if market volatility continues, we may see bans in larger countries in Europe and perhaps even in the U.S.
Keep in mind there was a one-month ban in late 2008 for financial stocks on the NYSE and Nasdaq. The hope was that it would stave off the massive drops in mega institutions like Bank of America (NYSE:BAC), Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and Citigroup (NYSE:C).
The result? It did little to prevent the bear market.
The main takeaway here is that during times of stress, it is critical to focus on the real problems. Banning short selling is just an unnecessary distraction.
Tom Taulli is the author of various books, including “All About Commodities” and “All About Short Selling.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
