SEC: Don't Mess with Market Mechanics

by: Jason Liu

With the SEC banning naked short-selling of brokerages, Fannie Mae (FNM) and Freddie Mac (FRE), financials have just been given the green-light to continue blaming someone else for their predicament. Banning naked short-selling may seem tempting as it would create short-term stability in the markets and keep Fannie Mae and Freddie Mac from requiring bail-outs. However short-sellers didn’t create the underlying problems in these companies and likewise, banning short-selling won’t make these problems disappear.

Its the first step down a treacherous road as the SEC will soon “draft rules to the same issues across the entire market”. As abhorrent as hoping a company fails may be, the primary reason for the existence of financial markets is to optimize the allocation of capital and short-selling is a crucial part of that. Without short-selling, you’re just encouraging the creation of asset bubbles and making it a lot more difficult a correction to occur. Imaginary creation of wealth can never last and the lack of short-selling will just make the subsequent crash a lot worst.

Short-selling is banned in China, one of the underlying reasons behind the >400% run-up in stock prices, and now the staggering >50% stock market crash. In the long run, banning short selling will only mask the many problems faced by the financial industry. And with the SEC’s track record of dealing with problems, maybe that’s all they want to achieve.