Tilted
..
Having seen some changes in the guidelines which govern fair value measurements last week, we now turn our attention to short sales.
The SEC is set to take up that issue today, and consider several measures which might limit short sales - the most oft-discussed of which is the possible revival of some version of the 'uptick rule'.
I don't think it hurts to reinstate it (other than on principle), but neither do I think it is likely to have as large a practical effect as some suggest. It could however, have a meaningful 'feel good' impact on general market sentiments. With the current trade platforms, it is possible to trade equities in very small increments. Sometimes, I trade stocks with a bid or ask containing 4 decimal places, on the dollar, per share (i.e. 1/100th of a cent - $0.8524/share). The potential effect of the uptick rule, in this environment, is significantly less than it was when stocks were traded in increments of eighths of a dollar, or even pennies. The rule may have a greater effect if it is bid based, as opposed to sale based. To be clear though, it will have an effect, the question is how much of one.
There are other measures being considered, such as a so-called 'circuit breaker', which would restrict short sales when an equity's price has fallen more than a certain percentage in a given time period. That kind of regulation would probably have more potential impact, for better or worse.
Placing small restrictions on short sales will probably be okay. However, we should be careful not to go too far. Short selling plays a very important role in keeping the markets healthy, and preventing dangerous bubbles which could burst with devastating consequences. All of the bubble bursts that we've seen in the last couple of decades, would almost certainly have been worse, if the precipitating bubble inflations had occurred in 'short-free' environments.
When it comes to short selling, we need to distinguish between two very different activities. One, being the recognition (or belief), for whatever reason, that the market has a over-valued something, being one of the early investors with the courage to point it out with your wallet (in spite of the consensus that you are wrong), and then earning financial rewards for your service, if you are right. That is fundamentally no different than recognizing that something is under-valued, and getting long in it, then being rewarded if you were right.
The other activity is not based on an honest belief that something is undervalued - but rather, it is a straight out attempt to manipulate the price of something in order to make money on the price's movement. In order to do this, people who understand how the markets work, take actions to intentionally drive down the price of a stock, despite the fact that it may have been appropriately priced to begin with. That can't always been done, but there are certainly situations where it can, and these market manipulators know how to recognize those opportunities when they do exist, and they have enough resources and knowledge to effectuate their 'bear raids'. But again, this is fundamentally no different than manipulating somethings price to the upside through various 'long' techniques.
For practical purposes, it would be good for the later activity to be curbed, because it can do damage to the markets, and more importantly, the nation's business environment. However, it would be very dangerous to limit the former activity, because it is essential to the health of the markets, and to the nation's business environment. So, therein lies the problem - how do you create regulations that can effectively differentiate the two? The answer is, you probably can't - so we just try to do the best we can. That probably means that we have to limit our regulatory efforts to those measures which will have only a marginal effect on both activities (although, it is probably true that the uptick rule would effect the later activity more than it would effect the former).
As a more general notion - when is it okay to restrict 'good' or 'acceptable' behavior, because we can't legislatively distinguish it from 'bad' or unacceptable' behavior, so that our only options are to allow both, or restrict both? That's a can or worms that we often find ourselves sorting through. Is the inability to legislatively distinguish actives, a sufficient excuse to restrict those activities which we otherwise would not have chosen to?
Back to the topic at hand. We will probably get some version of the uptick rule back. On the whole, that's probably good - the harm is limited, and the benefits are real, notwithstanding any debate over the depth and breadth of those benefits. But, again, we should not go to far - because doing so would be bad. As someone who is fairly active in the markets, I can say that I, for one, would be less inclined to hold a long-term position in a particular equity, if I knew that it wasn't open to short selling. For various reasons, short selling provides stability and limits volatility.
One last note, we shouldn't expect any uptick rule to be implemented soon. With modern trading platforms, it will take a while to work out the mechanisms.
So, what do the rest of you think with regard to short sale restrictions?
The SEC is set to take up that issue today, and consider several measures which might limit short sales - the most oft-discussed of which is the possible revival of some version of the 'uptick rule'.
I don't think it hurts to reinstate it (other than on principle), but neither do I think it is likely to have as large a practical effect as some suggest. It could however, have a meaningful 'feel good' impact on general market sentiments. With the current trade platforms, it is possible to trade equities in very small increments. Sometimes, I trade stocks with a bid or ask containing 4 decimal places, on the dollar, per share (i.e. 1/100th of a cent - $0.8524/share). The potential effect of the uptick rule, in this environment, is significantly less than it was when stocks were traded in increments of eighths of a dollar, or even pennies. The rule may have a greater effect if it is bid based, as opposed to sale based. To be clear though, it will have an effect, the question is how much of one.
There are other measures being considered, such as a so-called 'circuit breaker', which would restrict short sales when an equity's price has fallen more than a certain percentage in a given time period. That kind of regulation would probably have more potential impact, for better or worse.
Placing small restrictions on short sales will probably be okay. However, we should be careful not to go too far. Short selling plays a very important role in keeping the markets healthy, and preventing dangerous bubbles which could burst with devastating consequences. All of the bubble bursts that we've seen in the last couple of decades, would almost certainly have been worse, if the precipitating bubble inflations had occurred in 'short-free' environments.
When it comes to short selling, we need to distinguish between two very different activities. One, being the recognition (or belief), for whatever reason, that the market has a over-valued something, being one of the early investors with the courage to point it out with your wallet (in spite of the consensus that you are wrong), and then earning financial rewards for your service, if you are right. That is fundamentally no different than recognizing that something is under-valued, and getting long in it, then being rewarded if you were right.
The other activity is not based on an honest belief that something is undervalued - but rather, it is a straight out attempt to manipulate the price of something in order to make money on the price's movement. In order to do this, people who understand how the markets work, take actions to intentionally drive down the price of a stock, despite the fact that it may have been appropriately priced to begin with. That can't always been done, but there are certainly situations where it can, and these market manipulators know how to recognize those opportunities when they do exist, and they have enough resources and knowledge to effectuate their 'bear raids'. But again, this is fundamentally no different than manipulating somethings price to the upside through various 'long' techniques.
For practical purposes, it would be good for the later activity to be curbed, because it can do damage to the markets, and more importantly, the nation's business environment. However, it would be very dangerous to limit the former activity, because it is essential to the health of the markets, and to the nation's business environment. So, therein lies the problem - how do you create regulations that can effectively differentiate the two? The answer is, you probably can't - so we just try to do the best we can. That probably means that we have to limit our regulatory efforts to those measures which will have only a marginal effect on both activities (although, it is probably true that the uptick rule would effect the later activity more than it would effect the former).
As a more general notion - when is it okay to restrict 'good' or 'acceptable' behavior, because we can't legislatively distinguish it from 'bad' or unacceptable' behavior, so that our only options are to allow both, or restrict both? That's a can or worms that we often find ourselves sorting through. Is the inability to legislatively distinguish actives, a sufficient excuse to restrict those activities which we otherwise would not have chosen to?
Back to the topic at hand. We will probably get some version of the uptick rule back. On the whole, that's probably good - the harm is limited, and the benefits are real, notwithstanding any debate over the depth and breadth of those benefits. But, again, we should not go to far - because doing so would be bad. As someone who is fairly active in the markets, I can say that I, for one, would be less inclined to hold a long-term position in a particular equity, if I knew that it wasn't open to short selling. For various reasons, short selling provides stability and limits volatility.
One last note, we shouldn't expect any uptick rule to be implemented soon. With modern trading platforms, it will take a while to work out the mechanisms.
So, what do the rest of you think with regard to short sale restrictions?
