ASIC, one of our main financial markets regulators, has today declared that short-selling is a “legitimate business in the market”. Good on them. Markets need short-sellers, far more than most people realise.
The reason is that financial markets are markets in ideas – ideas about what will be valued in the future. And so they need people who are able, every so often, to loudly yell “Bullshit!”
It was short-seller James Chanos who called “bullshit” on Enron in 2001. And it was short-sellers who identified the problems with the US mortgage market a few years later, a story well told in Michael Lewis’s book “The Big Short”. In both cases, the short-sellers explained why the rest of the market was wrongly over-valuing those investments.
If only there were more such people, Enron and the US mortgage market might both have failed earlier and done far less damage.
In fact, if financial markets are to operate calmly rather than in the boom-and-bust mode that does so much damage, short-sellers should be encouraged. In the absence of short-sellers, markets will be full of people with an incentive to overstate the merits of particular investments.
Calls to limit short-selling featured prominently in the 2008 crisis, but they go back to at least the 1600s. People making money out of selling over-valued investments don’t like seeing their tall stories exposed. Their objections tend to be effective, because not enough people value the role the short-sellers play.
Bullshit in financial markets is too dangerous to be left alone. People need to call it early and often. We need more short-selling, not less.
Footnote: The only reason I’ve posted this is that it seems to be an extreme minority opinion. Almost everyone I talk to sees short-selling as sinister. Does anyone know why?