I thought I'd splurge some general thoughts about short-selling because I'm not sure that (so far) I agree with any commonly articulated viewpoint. These aren't very technical arguments, so I'm very open to comments/corrections from more expert views on what really happens. Anyway here goes.
1. I've always thought, and recent events reinforce my view, that stock-lending to facilitate shorting is an odd thing for long-term investors like pension funds to engage in. Put simply, you are renting your asset to someone who is going to tell the market that it's overvalued. By definition they expect the value of your asset to drop, and hope it does. And they aren't going to be shorting a company if they only think it's a bit over-priced. So unless you are making a bundle out of stock-lending to offset the potential drop in value this seems a bit counter-productive.
2. I don't think I buy the argument that shorting brings prices back to realistic levels. As I posted previously, academic evidence appears mixed. And real-world experience seems to point in the other direction - see the TMT bubble for details. Also this argument implies that those shorting are more rational, or have a better idea of the 'true' value of the stock, but why should that be that case? And even to entertain the idea that it were true perhaps - again thinking of the TMT bubble - the sceptics will never be strong enough to overwhelm the rampers. So perhaps all shorting does is accelerate and accentuate the drop when it comes.
3. Is shorting, as is sometimes implied, really just the mirror of going long? If so where do selling, and not buying fit in the spectrum? Isn't selling the opposite of going long and as such shorting almost a sort of leveraged position?
4. Pointing in the other direction, let's not fall into the trap of thinking that shorting is inherently more speculative than buying stock. Yes, those shorting typically only borrow stock for a limited amoung of time, but is this any different from those trying to profit from a post-IPO surge, buying shares in companies about to enter key indexes (and hence whose shares will be boosted when index-trackers have to buy), or engaging in momentum trading?
5. Equally let's be careful about the way we describe shorting. It's not really selling something you don't own, which makes it sound to the average punter to be almost fraudulent. It's renting something, selling it, buying it back, and returning it. Put like that it makes it much clearer that the person shorting is undertaking a risky activity but the ownership issues are clearer.
6. Time to hold our hands up - the corporate governance & responsible investment world I inhabit has appeared irrelevant by not making more of an issue out of this. We (me personally) have tended to focus on the obvious ownership policy issues - like what happens to voting rights when stock is lent - rather than focusing on the big stuff. The ability to vote on the report and accounts doesn't matter much if the company ends up being taken over/nationalised/etc.
So - where am I right and where am I wrong?