OPINION:
Markets plunged in Europe this week. The response in Spain and Italy has been an attempt to halt the collapse by cracking down on short sales. This is the equivalent of shooting the messenger.
Politicians vilify short selling because it involves the sale of stocks a trader does not actually own. It’s a complicated form of investment that only pays off when the news is bad, making it easy to blame the nasty speculators for those gloomy conditions. That’s what Spain did in banning short sales for all stocks for three months, while Italy imposed a one-week halt on short sales for a limited number of banking and insurance shares. The moves are meant to limit market volatility.
It won’t do any good. The economic problems underlying the financial market downturn will still be there when the bans are lifted, and markets will reflect this reality. It’s not the speculators who are responsible for the undercapitalized banks, growing public debt, increasing tax rates and highly regulated and inflexible labor markets.
As the global financial crisis kicked off in 2008, regulators in the United States, United Kingdom and several other countries either banned or severely restricted short sales, hoping to shore up financial-sector equity markets. In the United States, the ban stayed in place from Sept. 18 through Oct. 8, affecting almost 800 financial-sector stocks.
Subsequent research shows the policy failed. New York University’s Menachem Brenner and Marti G. Subrahmanyam explain that short-sale bans “throw some sand in the gears and delay the inevitable incorporation of bad news into stock prices” but are “largely ineffective in halting declines in stock.” A 2010 report by Oliver Wyman Inc. came to the same conclusion.
Short sellers perform a valuable function by facilitating the spread of information and price discovery, which is critical in improving marketplace efficiency. A ban on short sales decreases the number of buyers and sellers in the market, which also takes their resources out of the game, reducing liquidity. As a result, short-sale bans drive up transaction costs, fostering wider bid-ask spreads. That actually makes the market more volatile, not less so.
There’s no reason to believe that the outcome will be any different in Spain and Italy. Investors are shorting those countries not just because they are deeply indebted but also because their leaders aren’t doing anything to address the root causes of their distress. The politicians alone are responsible for the out-of-control public debt or the crushing regulatory and tax burdens on the productive sector. Lawmakers, however, need someone else upon whom they can lay the blame.
To return to a positive growth path, the bureaucrats in Madrid and Rome need to work on privatization and labor-market reforms — steps that generate loud, and frequently violent, protests from those living off the productivity of others. Why bother when it’s simpler to write laws and regulations to stop a legitimate market activity? The shortsighted moves are a sign that Europe’s downward recessionary spiral will continue.
The Washington Times
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