Bad News Ban Is Very Bad News

The SEC … said in a statement early Friday morning it is halting short selling on 799 financial stocks. The ban, which is effective immediately, is set to last for 10 days, but could be extended for up to 30 days.

That is, they have banned speculators from giving bad news about 800 finance companies.  Which seems to me to be very bad news about those companies – sell!  If not for the first amendment, would they also ban TV, newspapers, etc. from saying anything bad about these companies? 

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  • http://thomblake.com Thom Blake

    Yar, given the informational nature o’ short sellin’, I ken it should be covered under tha first amendment too!

  • http://beyondthecode.wordpress.com David Wynn

    This is an interesting point, especially the last statement.

    Yes, freedom of speech is good, and financial transactions are along those lines… but I don’t think the media has been doing a particularly good job with this situation either.

    Screaming “financial collapse” and “Great Depression” to a people who know next to nothing about finance is pretty analogous to shouting fire in a crowded theater. Don’t you think?

    Then again, I don’t think short selling gets reported very much, so I don’t see the point of banning short sales. Maybe they’re hoping a sliver of that profit made off of potential banks losses gets funnelled into their current capital stash instead?

    Unlikely, but possible I suppose.

  • http://occludedsun.wordpress.com Caledonian

    If not for the first amendment, would they also ban TV, newspapers, etc. from saying anything bad about these companies?

    It’s not the First Amendment, but the popular support for the First Amendment, that prevents them.

    Take a look at places that have little regard for the idea that speech should be free — like China — to determine how we would likely act if we felt similarly. Does China have a long record of denying or covering up truths that it feels would be embarassing or detrimental to its well-being?

  • Aron

    I certainly would resist any impulse to silence negative information. But here we have what I would think is a faith based question on the efficiency of our market implementation. Is there no room for the possibility that short selling creates a purely ‘technical’ self-fulfilling downward spiral? Are short sellers operating on superior knowledge at this point (if so why weren’t the positions taken when the stocks were much higher)?

    Should we really be saying at this point that the market after plunging so dramatically is not plunging sufficiently dramatically? That all manner of forces leading to fear and human stupidity must be allowed no matter how high the VIX goes?

  • http://denisbider.blogspot.com denis bider

    Robin’s comparison of short selling to other ways of communicating information is interesting.

    But there may in fact be a stampedo taking place.

    Like David Wynn said, is it okay to shout fire in a crowded theatre? Is that protected, free speech?

  • WTF

    Is this a correct definition?

    In finance, short selling or “shorting” is the practice of selling a financial instrument the seller DOES NOT OWN, in the hope of repurchasing them later at a lower price.

  • Mercutio.Mont

    “Like David Wynn said, is it okay to shout fire in a crowded theatre? Is that protected, free speech?”

    The SEC, by banning short selling, has done just that.

  • http://occludedsun.wordpress.com Caledonian

    Are short sellers operating on superior knowledge at this point (if so why weren’t the positions taken when the stocks were much higher)?

    Because if they *had*, the stocks would have been lower then.

    Like David Wynn said, is it okay to shout fire in a crowded theatre? Is that protected, free speech?

    The historical position was that if there were actually a fire in the theatre, that constitutes an absolute justification and defense against whatever negative consequences might arise from talking about it. If there was no fire, you could be held liable for any damage or harm that resulted from making the false statement.

    It is not clear that this is the model under which we currently live.

  • http://profile.typekey.com/aroneus/ Aron

    “Because if they *had*, the stocks would have been lower then.”

    Most likely. And if they were correct in being more negative than the market that still would have been the time to sell short.

    However, my question is whether short sellers now are balancing vectors of information or simply riding blind on a technical clusterfuck. By all means, in a normal environment allow short sellers to stake their positions. But isn’t it possible we’ve had a phase-change from rationality to emotionality? It seems blind faith to take the general principal and assume it operates in all environments.

  • http://www.iphonefreak.com frelkins

    Ahoy Denis

    “Robin’s comparison of short selling to other ways of communicating information is interesting.”

    Yar, Bucko, ’tis how we on the account handsomely predict the swag an’ pieces o’ eight a-fore we open the guns. All hands place their bets at the first sound of sail ho.

  • http://neuraltransmissions.wordpress.com MZ

    is it okay to shout fire in a crowded theatre? Is that protected, free speech?

    The current ban may be more like a prohibition on shouting fire in a burning theater.

  • http://occludedsun.wordpress.com Caledonian

    But isn’t it possible we’ve had a phase-change from rationality to emotionality?

    Of course! But that’s not the point.

    The point is that, although it may well be possible to find specific individuals whose ideas about how people should respond to situations like this would be better in implementation than what the market actually does, it is extraordinarily difficult to identify those people ahead of time — and the vast majority of opinions people have on the matter would be worse, if put into practice.

    The point is not that the system is perfect and ideal, but that we are unlikely to do better than it even in specific situations and ludicrously unlikely in the general case. There will always be someone who is sure that they know better and that the system should be abolished in favor of what they want us to do — there will always be many such someones. But they cannot all be indulged, nor should they be.

  • http://www.genc-lider.com Genc Lider

    thank youuu

  • http://yudkowsky.net/ Eliezer Yudkowsky

    I heard this news last night, and thought, “Can that really be as stupid as it sounds?”

    Now that the efficient markets are being hobbled, I wonder if there’s some way to profit from this that isn’t already being exploited. This morning might be a great day to be a financial professional.

  • http://profile.typekey.com/aroneus/ Aron

    “The point is not that the system is perfect and ideal, but that we are unlikely to do better than it even in specific situations and ludicrously unlikely in the general case.”

    But we can do better than it, because ‘it’ is not fixed in stone but is a human construction that we have evolved over time. That in all scenarios, the same rules should apply, is not something to take for granted. Are trading curbs bad? Insider trading rules? Ownership disclosure regulations? FD disclosures? Margin limits?

    Banning short selling looks asymmetric but the market is itself asymmetric. How many times has a company’s stock performed in the reverse direction of AIG’s, or some of the banks that have collapsed?

  • http://initforthegold.blogspot.com Michael Tobis

    I think it’s a brilliant move and should be taken further. It should be made illegal to sell securities for less than you bought them for.

    There! The whole problem solved with the stroke of a pen!

    Right? Or did I miss something? ( :>))

  • realcox

    they’re doing this in pakistan already. stocks are down 25% since

  • billswift

    is it okay to shout fire in a crowded theatre?

    Damn right, if there is a fire.

  • Jason

    Billswift, how do you feel if by shouting fire, you create a fire, and are therefore vindicated.

    Besides the fact that they didn’t actually ban short selling, (see my post on “Ban the Bear”) counter party risk is a huge fear in the financial markets.

    So the short sellers shout fire, sending the theater goers running in panic (clients, creditors, partners, etc). This particular theater is using torches for lighting (this is about as stupid as the investments banks have been) and the people in flight knock over the torches, starting a fire.

    Its the same concept as a “run on the bank.” The reason we created FDIC insurance was so there wasn’t runs on the bank. Otherwise, everyone looks out for themselves and everyone loses as a result (if no one pulls out, 80% chance of survival, if everyone pulls out, 0% chance).

    sounds like a prisoner’s dilemma to me.

  • Grant

    The historical position was that if there were actually a fire in the theatre, that constitutes an absolute justification and defense against whatever negative consequences might arise from talking about it. If there was no fire, you could be held liable for any damage or harm that resulted from making the false statement.

    I found this particularly apt for describing shorting: If the stock was overvalued, no crime is done. If the stock was not overvalued, we’ve reduced someone else’s utility. However, unlike the freedom to shout “fire!” whenever we want, this “criminal” shorting already punishes the shorter. Just because there ain’t a law against it don’t mean it doesn’t carry penalties.

    I don’t see the connection to bank runs. If a shorter undervalues a stock, others should push back against his shorting. If everyone undervalues a stock, the stock price will drop for a time. But an under-valued share price doesn’t cause a company to go bankrupt. The worst that happens is some other business snatches them up for a discount, or the board gets pissy for a while. A dropping share price indicates the market thinks that a company’s fundamentals are unsound. Unless I’m grossly mistaken (and I often am!), a dropping share price does not cause a company’s fundamentals to become unsound.

    Plus, you aren’t screaming fire to a bunch of ordinary people in a theater; you’re screaming it to a bunch of firefighters (i.e., professional traders).

    Its always seemed to me that SEC regs could be internalized by individual exchanges anyways.

  • Jay

    The ironic thing is if there was a way to short house prices directly, there would not have been as extreme a housing bubble and these financial firms would not be in the trouble they are in.

  • http://occludedsun.wordpress.com Caledonian

    But we can do better than it, because ‘it’ is not fixed in stone but is a human construction that we have evolved over time.

    I cannot properly understand the confusion of ideas that would be responsible for such a statement.

  • http://profile.typekey.com/aroneus/ Aron

    The confusion comes from the fact that I was talking about making a special-case change to the rules of the marketplace (banning short selling due to emotional panic), and you replied that a single person (or group of individuals) can’t be trusted to outperform the market. Not exactly a conversation on the same page to start with.

  • http://www.hopeanon.typepad.com Hopefully Anonymous

    Here’s the SEC’s direct word on why they did the short sell ban.

    http://sec.gov/news/press/2008/2008-211.htm

    And here’s Christopher Cox’s wikipedia page: one can say at least that he seems to have the necessary domain competence for the job.

    http://en.wikipedia.org/wiki/Christopher_Cox

    So, is the SEC’s press release propaganda? How would you, Robin Hanson, deconstruct their explanation for the short sell ban?

  • http://occludedsun.wordpress.com Caledonian

    The confusion comes from the fact that I was talking about making a special-case change to the rules of the marketplace (banning short selling due to emotional panic), and you replied that a single person (or group of individuals) can’t be trusted to outperform the market.

    How else do you imagine the rules change would be made, Aron?

  • frelkins

    Just to follow up, an academic paper on the history of this ban have come out, and what it says should be no surprise – it was a bad idea that made the market worse – more volatile, less liquid:

    “Stocks subject to the ban suffered a severe degradation in market quality, as measured by spreads, price impacts, and intraday volatility.”

    What I found interesting personally – that for a week after the ban, there was less shorting than usual. So the ban harmed the informational quality of the market for a time even after it had ended!

    The authors say in sum:

    “the temporary shorting ban is over, yet the stresses on the financial system do not seem to have abated. It may be too soon to judge, but we suspect that after some time has passed, future observers will look back at this shorting ban with the same kind of wonder that economists reserve for Nixonian price controls and other similar government interventions. Those future observers will probably ask: did they really think that would do any good?”

  • StreetWalker

    And the UK now has lifted its shorting ban, in response to which traders took the Royal Bank of Scotland down, based on its holdings of American MBSs and what seems like a now-questionable merger with Dutch bank ABN-AMRO:

    “Stephen Hester, the chief executive of the Royal Bank of Scotland, criticised the decision to lift the ban on the short-selling of banking shares yesterday as he saw his own bank’s price collapse by more than 66 per cent to only 11.6p.”

    The Royal Bank of Scotland was worth BP75 billion(!) recently – but froze in the credit crisis this fall and received BP32 billion in bailout money from the UK government. After the shorting run today, the bank is now worth just BP4.5 billion: more than BP100 billion in value destroyed.

    It appears the UK ban on shorting did as little good as the American, and prolonged the death of the Royal Bank of Scotland in the most expensive manner possible. If short sellers had been allowed to give their bad news about their estimates of the worthlessness of the bank’s American holdings earlier, at least the UK government would have been able to nationalize it sooner, reducing the length of the crisis, perhaps rescuing some jobs, and possibly saving that BP32 billion in bailout funds.

  • http://ahappinessexperiment.wordpress.com/ Bock

    Optimism is the opium of the people!

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