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Why all the fuss about short-selling?

 

Markets have existed throughout most of recorded history.  Although our earlier predecessors bartered agricultural produce and necessities the fundamental nature of markets penetrated their nomadic societies.  To be clear a market is a meeting place between buyers and sellers. Markets today are vastly more complicated and asymmetric information adds to this complexity.

Mutual funds are generally long-only imposed by regulation. This restricts the ability to identify market opportunities in seeking the highest yield lowest risk positioning for their fund, somewhat, one could argue hindering their fiduciary responsibility and in protecting their investors assets. I am not advocating that this position should be reversed entirely, but I do believe that mutual funds should be allowed some capacity to short.

Short-selling is a blessing to markets, which regulators should be thankful and appreciative of.  Short sellers have made the jobs of the SEC and other federal regulators easier, pinpointing exactly companies with sketchy practices – Lehmann, Enron, Allied Capital and recently a container full of Chinese reverse mergers and more interestingly sovereign debt. If a security is over-valued there should be a mechanism available to investors to seek to correct that imbalance.

Markets are supposed to be efficient and if natural mechanisms are removed to correct imbalances markets are likely to become dysfunctional with visibility being reduced. It’s peculiar that the SEC is seeking to make markets more transparent while in fact it is creating the opposite environment. Short sellers deviate from the norm, usually having a bias against the established position, they build momentum, influence management, competitors and the industry at large.

Short sellers typically focus on companies where the fundamental business model may be in question and short sellers will attempt to capitalise on any weaknesses the company may exhibit – for example Blockbuster, Borders, HMV, the banks and this is all a reflection of a new reality. Markets are supposed to be transparent and should adjust to new economic circumstances.

In short (no pun intended!) short-selling is making a market by taking the opposite side of a trade; we should respect them as a market participant. Longs in financial securities are not heckled and accused of profiting by encouraging their stocks so shorts should not be accused of trying to profit by explaining their side of the story; transparency is the key and that should be the focus.