Banning short selling doesn’t stop markets falling

All those who heralded last week’s move to stop short selling of financial shares on both sides of the Atlantic wanted to believe that short sellers were responsible for the market fall, and thought a regulatory change could stop it.

Yesterday showed how wrong that was. Wall Street plunged another 3%. Markets can and do fall because holders of shares lose confidence in the financial world and want to get out. Markets can fall because holders of cash see no reason to invest it in shares. Those forces were always the main ones driving these Stock markets down this year, and they remain the main ones following the regulatory bans.

There is no quick or easy regulatory fix which will stablise the markets. The markets now are mainly driven by the actions of governments and Regulators, especially those of the USA. It was the decision to save Bear Stearns, Fannie and Freddie which limited declines. It was the decision to let Lehmans go that undermined confidence and started the big further falls. It was the decision to bail out banks with distressed debt which led to the huge rally – along with some short covering following the regulatory change – and it is worry over the bail out package that led to yesterday’s sell off.

The world’s financial markets are dependent on the US Treasury Secretary and on what Congress makes of his Bill. In that sense government is very important. What markets are waiitng to hear is how much money will be committed and on what terms. Until they know that it is difficult to establish sensible values for shares.


  1. Johnny Norfolk
    September 23, 2008

    I think it was a very dangerous move. What happens in January will the dam burst ?

  2. Acorn
    September 23, 2008

    As the amateur economist on this site; and having read copious amounts on the subject since last Friday; I am now in favour of this solution. What do you think?

    “A Matched Preferred Stock plan for government assistance”.

  3. Pete Chown
    September 23, 2008

    Suppose the depositors' protection scheme was extended to cover all deposits, not just the first £35k. This would prevent bank runs, improving the stability of the system.

    Although the government is not saying so explicitly, they seem to be going further than this in practice. Although shareholders have lost some money, the government has protected institutional lenders as well as retail depositors. They have managed things so that the good banks take over the bad banks. Shareholders who chose to invest in good banks will lose out, but the people who lent to bad banks will be protected.

    One of the lessons of the twentieth century is that market discipline works, and government management of the economy does not. At the moment, we have a problem, and the temptation is to "fix" things by repeating this twentieth century mistake. Just as British Leyland was seen as too big to fail, we now cannot imagine allowing something as big and important as a bank to go bust.

    Suppose Northern Rock had simply gone into administration. If my enhanced compensation scheme had been in place, no depositors would have lost out. In fact, while the administrators kept the business running, there wouldn't even be any reason for them to take their money out. Meanwhile, institutional lenders would lose, but they chose to take the risk of investing in this particular business.

    1. mikestallard
      September 24, 2008

      In last week’s Spectator, your idea was discussed by an important City luminary. As far as I could understand it, he totally agreed with your view – except for just one thing.
      In the event of a crash, the management and shareholders should be dismissed and a sort of receivership put in place instead.
      That might give a little of the “moral hazard” back.

      1. Pete Chown
        September 25, 2008


        That’s interesting. I was imagining a system similar to the one you described. It would be wasteful to put a bank into liquidation and sell its assets at fire-sale prices. It would be much better to keep the business running while the problems are addressed, either by the appointment of an administrator, or with a new scheme like the one you are describing.

        Suppose this had been in place when Northern Rock got into trouble. First of all, there would be no rush for retail depositors to withdraw their money, as it would all be 100% guaranteed by the government. Instead, institutional lenders might refuse to roll over loans, to the point where the Rock couldn’t meet its obligations. At this point, an administrator or receiver would be appointed.

        This person would look around for someone to buy the business. Perhaps he finds that he can get a buyer if the shareholders lose their investment and the creditors lose 10% of their loans. Northern Rock would then be sold on these terms. The Treasury would take the 10% hit on behalf of the retail depositors, and the institutional investors would get 90% of their money back, forfeiting the rest.

  4. figurewizard
    September 23, 2008

    The sharp rise in share prices last Friday, in which the banks were far and away the best performers had as much to do with the banning of short selling of financial stocks here and in the US as George Bush’s commitment to support MBOs. Those with short positions were forced to buy urgently in order to limit potential losses and prices went up in response. By Monday this factor was largely played out and a banking share price hangover has begun as a result. If ever there was an example as to why governments should think twice before sticking their clumsy fingers into the markets in order to play the populist card, this was a good one.

  5. mikestallard
    September 23, 2008

    How do you ban short selling? Why can’t it come back as, for instance “Hedge Funding”? Is someone going to ban transferring any stocks at all?
    How do you stop “fat cats” getting bonuses? Look at MEPs’ expenses, for heaven’s sake! how do you control even them?
    How do you, in real time, know what to regulate and when? The FSA has a new (Labour approved?) head, so that means that it must be considered important by the government. Also, the Prime Minister’s speech showed that “we” are not going to put up with the stock market getting out of control. “We”, (I am afraid), are also going to put matters right in the near future (or words to that effect.)
    Myself, I think I am going to start off as a brain surgeon. I know what to do because I am a good person and I BELIEVE in what I do. One of my own family has a brain. Anyone want me to operate on them? I have already sharpened my scalpel and wiped it clean on my trousers……..

  6. Bazman
    September 23, 2008

    I don’t really believe this practice had any effect on the future of any company. Just accelerating the inevitable, but is a millionaires scam.

  7. Nicholas Taylor
    September 23, 2008

    Would it would have been better if the US administration had brokered a deal for other companies to buy the failed banks instead? Would this have driven up confidance more than very expensive nationalisation?

  8. Adrian Peirson
    September 24, 2008

    From a Russian Viewpoint.
    You see, Money should have real, not just perceived value.

    1. Bazman
      September 24, 2008

      Very true Mr Peirson. In Russia and in particular the Samara region. A transit point in Russia, life is very fast especially money. The Federal government is not to be trusted. Better to drink your money away in one day than have it stolen by currency changes. If they say the money will not be changed. It will be. The person who said this will be sacked and then get a better job. I have seen this. Dollars and recently the Euro Dollar are a seen as a way to save.

  9. APL
    September 24, 2008

    JR: “Banning short selling doesn’t stop markets falling”

    No, but it may well have contributed to a reduction of liquidity in the Market.

    So, Brown can say he has wacked the Shorts, and maybe he did. The thing is, that will play well with Brown’s supporter during the conference.

    But what this illustrates is that a politicians will sacrifice anything and anyone to boost his or her career.

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