There are two rather different perspectives on the FSA's intervention in respect of shorting out there on t'interweb. Chris Dillow is critical, whereas Robert Peston is broadly supportive.
Being a fence-sitting type, I can see logic in both arguments. Shorting ought to have the potential to make markets less prone to overvaluation. As Chris points out, some investors (index trackers) have to buy certain stock which can falsely inflate the price, for example when a stock enters an index. In addition maybe he's right to argue that a bit more shorting might have prevented the TMT bubble expanding as it did.
On the other hand Robert Peston makes the point that shorting can be bad news for those that facilitate it - the stock-lenders. Pension funds and insurers lend stock for the fee income they derive from it, but what if the shorting that takes place depresses the share price significantly, and thus pushes up the cost of capital for the investee business? Is that really in their long-term interest?
Two more points swing me more in Peston's favour. First, does shorting really make prices more 'efficient', or does it just push them in a certain direction (if it works)? Surely shorting can push prices to an unreasonably low level, especially if it triggers further selling? That's no more efficent than overvaluation.
Secondly I have a broader concern about the impact of stock-lending - it can be a negative in terms of corporate governance. Not all institutions recall stock in order to vote for example, even when there are contentious issues at stake. As an example I came across a pension fund that wasn't able to vote on James Murdoch's appointment at BSkyB a few years back - a huge governance issue at the time - because it couldn't recall its stock.
In fact, as I posted last year, stock-lenders get the message that recalling stock for voting can make them a less favoured option. So there is commercial incentive not to recall in order to vote. Of course these are criticisms of stock-lending rather than shorting, but it's another factor to consider.