SEC Panic Raises Odds of Major Market Meltdown
Short selling has been restricted lately, with naked shorts on financials being forbidden. Short selling is when you sell a stock now, borrowing it, then buy it later (hopefully after it’s dropped in price). Naked short selling is when you don’t borrow the stock, but sell it anyway. You then have 3 days to deliver the stock.
Over the pond, in yonder Britannia, they decided to ban just not all naked shorts on financials, but all shorts on financials period. The SEC is trying to decide if it should follow suit, or if it should go all in and ban all short selling, period.
This smells of panic driven decision making. Regulators are in a cold sweat, and they haven’t thought this through. Short selling, ironically, provides market support. If you sell a stock you don’t have, that means you are now on the hook for it. As the price declines, you have to buy. You become built in support. One of the ironies of short selling is that it makes steep and precipitous declines less likely. Huge amounts of short "interest" on a stock means that it also has huge amounts of built in support on the way down.
Getting rid of short selling entirely doesn’t make market meltdowns less likely. It makes them more likely. Just as letting banks use depositor money to shore up investment banking subsidiaries is throwing good money, your money, after bad. Just as allowing banks to book "good will" as regulatory reserves doesn’t actually change how likely they are to be insolvent.
Regulators are making decisions in the grip of stark fear and their critical faculties aren’t working anymore. Desperate to stop a meltdown at all costs they are making one more likely, and by letting banks gamble with depositor money, making it more damaging if it does occur.
(Note: Original definition of a naked short was wrong. Corrected.)