The Daily Show Goes After Short-Selling

March 18, 2009

Let me just preface this by saying that NOBODY is a bigger fan of the Daily Show with Jon Stewart than I am. And 99% I’m on board when it comes to their take-downs. But I was of their bit 2 nights ago when they went after short-sellers.

For those of you who don’t know (or, more likely, never cared to know!) what short-selling is, it is simply a bet that a stock’s value will go down. A short-seller borrows shares of stock and sells them. They then have to buy an equal number of shares back to return to the lender. If the stock’s value went down between the selling and buying, the short-seller makes a profit. If the price goes up, they lose money.

The Daily Show (it was a Samantha Bee skit) characterized this practice as somehow nefarious. As Samantha Bee put it, it may not be killing the guy, but it’s robbing his grave. Two arguments were implied: (1) it is immoral to profit off of company losses that leave workers unemployed, and (2) short-selling in itself can drive down stock prices.

Now I’m the first to admit that my knowledge of the financial world is pretty small. I do know, however, that I am far from alone in thinking that short-selling is actual a useful and beneficial practice. It provides market liquidity, it contributes to price discovery, and it provides investors a way to hedge.

In September of last year, the SEC actually banned the practice for nearly a month for about 800 stocks, following the argument that during times of market volatility, short-selling can lead to runs and panics. After a month without short-selling, however, the evidence that this somehow mitigated financial losses is unclear at best. And at worst, the ban actually depressed stock values, as some who had taken short positions had to wait to buy stock back, meaning that there were less stock purchases than there otherwise would have been.

Indeed, the Daily Show crew aren’t the only ones going after short-sellers, and they aren’t the only ones arguing that it is immoral and can fuel plunges in stock value. But at a minimum, they’re making what appears to be a cut and dried argument, when in fact many and quite probably most economists believe the practice is not only legit but necessary to prevent inflated stock values and to provide more accurate price discovery.

Now, this says nothing about some of the shadier ways in which short-selling has been done, such as “naked” short-selling, in which, in a nutshell, no stock is actually borrowed. This also says nothing about the argument over reinstating the “uptick rule,” which allows sales only after the stock has gone up. I’m just saying that at a time when there are more Wall Street bad guys and bad practices out there than you can shake a stick at, do my heroes at the Daily Show (and they are my heroes!) have to go after a practices that could very well be legit?

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