Should short selling be banned?

Someone who sells a car that he does not own is not seen as someone serving the used car market by his innovative creativity as a short seller. Rather, he is seen as a crook and very likely to go to jail ...

Sure, this is a rather drastical comparison - but thoughts about better market regulation are not evil, rather very necessary.

Stock Markets arround the world have always operated short selling. Have you heard of Bull and Bears?

Stock markets are different to buying and selling cars or for that matter most other markets and no comparisons can really be made. You must realise that financial markets operate in a vastly different way

There needs to be more knowledge and understanding of short selling in the media and people should not be buying a message that is based on limited knowledge

The debate has attracted one MP that has been proposing a short selling ban and its a great chance to balance the argument and get more knowledge into this topic 

The man on the street will always make comparisons closer to their everyday experiences. Continuing with the comparison with used car sales, it is legal for a used car dealer to strike a deal without owning the car as long as s/he commits delivery on a future date (by which time the seller is sure of sourcing it). It only becomes a crime when the seller is unable to deliver on the committed deadline. The same thing applies for short selling of stocks. 

Remember that selling short is a contracted commitment to deliver. Failure to deliver can incurr costs. The risk is that the share price increases and the sky is the limit making the short seller taking huge risks. For this reason short selling has to be covered by margin and collateral

Short selling products are where most people are confused and where the regulators need to ensure that there is good margin and collateral

The comment about potential short selling of used cars is of course well put. My initial comment was not meant to suggest that short selling should be seen as illegal per se - the context was that better regulation may make good sense from a macroeconomic point of view. Short selling may be useful in various situations, but it became questionable whether our economy really needs the high volumes of short selling seen today, or whether this means danger. When there is danger, it is common practice to introduce some regulation, like speed limits on roads ...

The underlying fundamental question is whether the real world economy is to serve the financial markets or the other way round. Most people do live in the real world and would suggest that financial markets should serve (rather than dominate) the economy.

This would also be reflected by market volumes in financial markets being better aligned to the volume of goods and services produced in the real world ...

Things have grown somewhat out of proportion over the recent years, and so it is no surprise that our democratic society now starts asking questions.

Quite simple really. Ban short selling and dry up liquidity. For example when the market is moving into a Bear. Investors holding shares wont be able to sell because there will be no buyers

In some countries 9mainly Far East) short selling was illegal. This prevented international investment and dried up their ecnomies. During my research for this topic it has been interesting that the further East the more moral arguments appear and ilegal comes into the argument. The further West you go and the reverse view is made. This indicates a culteral influence as well as an historic standpoint

However some of the biggest users of short selling products are from the Eastern countries. Strange 

@GaryW:

Please correct me if I'm wrong: In short selling, success in delivering itself incurs potential risks of stock price going up (instead of down, as the short seller expected), whereas failure to deliver attracts penalties from the stock exchange. 

@StephenS:

We might be living in a political democracy but, when it comes to the business world, capitalism rules! To me, Main Street and Wall Street are too tightly intertwined for any clear master-servant relationship to emerge. For every SELL transaction, there is a BUY transaction, as long as the financial market supports the volume, I don't see any need to artificially keep it suppressed by real world volumes. There were homebuyers underlying subprime mortgage security. Some banks got bailed out using taxpayer funds, as were Main Street companies like GM, but many of both were also shuttered down. 

The risks with short selling are all with the seller. They have to buy to cover the sale and if the buying price keeps going up they lose. Sky is the limit for losses on short selling and why it should only be alowed for proffesional traders with big balance sheets.

Dont get confused with Sub prime that was not short selling just lending against collateral that was not large enough or with enoth quality to people that could not repay. This was not short selling but a breakdown of valuations within the banking and others in the financial system

Nice debate. I learned a lot and that Short Selling is maybe not so evil (just a little unintuitive).

But on the last point here - I don't really think there can have been enough bad 'sub-prime' mortgages to cause the damage and debt seen.  It was way bigger than retail mortgage lending.  Money was leaking out elsewhere leaving a big void that collapsed in on itself.

From the last time this was discussed :)

Still haven't heard a convincing argument for allowing short selling (except for market makers).

Imagine you're got to explain this a teenager - come up with a scenario or story where this makes sense.  You say it increases liquidity, how is that and what would be the consequences of not having short selling?

Thanks for the useful comment by "Finextra member" on the volumes involved (and needed) to generate the most recent financial crisis. It is indeed quite likely that we saw the collapse of a big void ...

Now this brings me back to a earlier comment by Kethamaran S. who stated: " I don't see any need to artificially keep it <market volumes> suppressed by real world volumes."

I'd beg to differ. If there were better regulation keeping financial market volumes more in line with real world volumes, such unhealthy inflations could be prevented. This may be to the displeasure of a few people making huge profits out of this, but would be beneficial for the rest of society. 

Just to try and explain the liquidity issue on short selling

Imagin you want to buy shares in a company or currency and there is no one to sell it to you because they operate a matched position. What will happen to the asset you want to buy?

Well in a bid scenario you could keep bidding higher to try and attract a seller. In which case you will pay much more than you want. This is called an illiquid market

Now the same scenario

A wholsaler will sell you shares and currency at an agreed price and supply you with the asset by borrowing it from a holder/investor

This is supplying liquidity to the market and you get the asset at the market price because its liquid

Now with short selling OTC products there are speculators that can buy this products at a small outlay providing them with huge exposures to the market. If large enough or piched at the right time it can adversly affect the market. This is not short selling and should not get mixed up with the need for liquidity.

The problem with this type of financial instrument is that its off market and billateral between large entities. It does not need a huge balance sheet and it has become unregulated through complexity and just plane bad regulators. They are not margined and collaterised to the extent that they should be. This is uncovered naked exposures but not short selling

During my research for Short Selling and why the Post Trade Forum debate has been arranged is because people do not make a distinction. Prefering to bag everything under Short Selling. The risk is that the baby and the bath water will be on the floor and we will create an expensive and illiquid market that has severe unintended consequences

So now get all the apples and pears together

Should Short Selling be banned? 

"Imagine you want to buy shares in a company or currency and there is no one to sell it to you because they operate a matched position. What will happen to the asset you want to buy?

Well in a bid scenario you could keep bidding higher to try and attract a seller. In which case you will pay much more than you want. This is called an illiquid market ..."

So, what's wrong with an illiquid market ? Isn't that just a very common situation in the real world ?

If I want to buy a nice house in a particular area and nobody there wants to sell, then I will have to bid more or I will have to wait until someone wants/needs to sell.

If I do want to buy now and thus have to pay more than I would like, then I'm still just paying the fair market price at that particular time.

In financial markets there are market makers to help in such situations, and that's fine. But there ought to be measures to prevent gambling on inflated volumes.

You got it

Market Makers take the risk and need the facility to sell short. By creating liquidity they are facilitating a market without this facility there would be no market and stagnation and you say buyers or investors would be paying a very much higher price. I assume no one wants to pay high prices

Fine with me ...

But can we also agree that market makers do a useful job when there is too little liquidity - and that there are also cases when there is just too much liquidity and hence, we see dangerously inflated market volumes ?

In such cases, some damping mechanism ought to step in - just like having speed limit signs at dangerous road sections. I don't believe that this would mean re-implemeting communism ...  (;-))

Now i am confused again! Too much liquidity in the market?

Markets are either liquid or not! There are not degrees of liquidity

The concentration must be to find ways of regulating who is buying products that creat massive shorts and how this OTC products are used. I see no reason why a creator of an OTC should not be procescuted if it is proved detrimental to the market. This could be market manipulation of which there are already regulations but possibly not applied.

This again is an area i will be raising during the Post Trade Forum debate as i do not think that the current push of OTC into clearing houses will acheive all that is expected.

I agree we do not want communist type restrictions but we do need responsible markets that operate for the benefit of society and where risk takers are rewarded for success but not at the expense of investors. Crumbs the markets used to do this really well