Short stuff

There's an interesting piece on Robert Peston's blog today about the FSA havning another look at shorting. The argument is, it seems, that given the current fragile state of market confidence allowing speculative attacks on, say, HBOS might create a self-fulfiling story of imminent collapse.

I just want to focus on this bit:

First, short-selling (as I've said many times) is not evil, in and of itself. In fact, short-sellers perform a public service when they take a risk to puncture the over-valuation of assets, as they routinely do.

This is the first line of defence against a clamp-down on shorting. Some argue that it's a shame we don't have a short-able market in respect of housing as that could have prevented the bubble there. But is it actually true? I've only taken a very brief glance at some of the academic evidence in respect of the impact of shorting on asset prices, but it seems that the picture is mixed.

This paper (PDF) says that "relaxing short-selling constraints lowers prices in experimental asset markets, but does not induce prices to track fundamentals". Another paper, The robustness of bubbles and crashes in experimental stock markets, seems to argue that shorting doesn't have an impact on the formation of bubbles. A third paper says the opposite - shorting brings prices back to fundamentals. Three different views on the same issue. Why therefore should be take at face value claims from those employing shorting that it's not doing damage, and actually is even beneficial?

I don't have a strong view here, though I'm inclined to think that at times like the present shorting may not be good news for the stock-lenders (such as pension funds) who facilitate it, since they have a much longer-term perspective. A crisis in confidence might take out a company in which a fund has quite a lot tied up. What they gain in stocklending fees might be offset by losses in the value of shares. As such they may think that temporary restrictions might not be a bad thing.