"The problem is that short selling is viewed as un-American," USC finance professor Lawrence Harris, a former SEC chief economist, told me. "But it's very important."
That's because unalloyed optimism is unhealthy for capitalism, as living on a diet exclusively of Twinkies would be for you or me. Almost every participant in the system wants to see markets rise, so the general impulse is to suppress bad news and play up, or even make up, good news.
Short sellers provide a necessary corrective to this tendency. Shorts sounded early alarms about Enron, WorldCom, American International Group and failing investment banks, albeit generally to a blinkered and willfully deaf investment world.
Consider the experience of Jim Chanos, an outspoken short who turned his cynic's eye in 2000 (not for nothing is his investment firm named Kynikos Associates) to Enron's financial statements. There he discovered all sorts of shenanigans hiding in plain sight.
As Chanos told Congress after Enron's collapse, he checked with several Wall Street analysts who were following the company, only to be struck by how many "conceded that there was no way to analyze Enron, but that investing in Enron was instead a 'trust me' story."
Chanos fattened up his short position in the company, presumably reaping a windfall when it fulfilled its destiny by going under in 2001.
Obviously, it's more convenient for a CEO to bellyache about short sellers ganging up on his stock than to confess that he's run his company incompetently or dishonestly. Yet executives invariably get a sympathetic hearing from Congress and regulators.
Just last week, six U.S. senators hectored the SEC to do something about "abusive short selling" and "manipulative short selling" which, they said, "simply must end."
This despite the absence of any evidence that short sellers manipulated stocks in any of the truly spectacular flameouts of recent months. Bear Stearns, Merrill Lynch and Lehman Bros. were all firebombed by their own managements with no help from the outside, thank you very much.
On the other hand, there's evidence that the regulations now under consideration by the SEC will be useless or unfair, or both.
One idea, for example, is to restore the "uptick rule." Eliminated in 2007, this Depression-era rule prohibited executing a short sale on a stock unless the prior trade was at or above the previous price. The idea was to hamper "bear raids," in which a cascade of short sales relentlessly pressures a stock lower.
