And, to be fair, during a bubble going long must be banned.

I wish people would stop making this out to be more than it is.

The financial markets are built on confidence and trust. Counter-party risk is very real.

What many people do not know is that mid-2007 they changed the criteria to short a stock. Previously, you could only short on an uptick. Now, that requirement is gone.

Using a combination of naked shorts and shorting on DOWN ticks you can quickly create a huge run on a stock. This spooks counter-parties, big time, especially in crisis of uncertainty and rumors.

Spooked counter-parties then stop dealing with the targeted stock. Credit lines disappear or become more costly. Partners break ties and look elsewhere. Clients pull out.

Essentially, the short attack reverses the usual bad business = bad stock price. Instead bad stock price = bad business.

The SEC simply made it harder to short (they didn't BAN anything) and reinstated the requirement to short on an uptick.

Not saying its ideal, but you can understand the idea.

The capitalists are trying to save capitalism from the capitalists!

do you live in a cave? shorting is prohibited on those 799+1 until 10/2, period.

In response to Jerry: I don't take a great deal of exception with most of what you say. I do, however, take issue with the idea that the banning of shorts in certain securities was the responsible thing to do in the current environment. If anything the markets should have just been closed for as many days as it took the SEC & Congress to figure out what they wished to do about this "crisis of confidence" (the most likely course of action will of course be a trillion dollar ,government funded, waste basket used to absorb bad assets and allow brokers to de-lever). Closing the US stock market is hardly unprecedented. Instead, the government chose to rip-the-face-off (that's a technical term) of many legitimate alternative investment managers who had fundamental long and short positions in place. It is a gross and irresponsible redistribution of wealth from hedge fund investors (the largest of which are pensions) to long-only fund investors (the largest of which are pensions).

It may also have been an outright attempt to manipulate the stock market higher in order to provide the volume needed to liquidate the ~$800bn in Lehman assets that need to be sold.

The ability to sell stock short did not create massive amounts of leverage on tiny pools of capital and temporarily banning it won't fix that root problem either.

The Onion: "Bush to Cut Deficit from Federal Budget"

Hmmm. How could they go up if they were never sold?

Russ 2000:

That's the funny part of the whole week. The government is trying to increase liquidity with one hand and decrease liquidity with the other. We have so many regulators we effectively have no regulation (but lotsa transaction costs).

Well put.

whatev, they banned NAKED shorting.

The problem with short selling is that it adds another dimension to buy and sell, the buy side does not have the same instrument. Not to mention naked shorting which is even worse, that way you don't even have to borrow the shares before you short them. Short selling is a kind of self-fulfilling prophecy.

Ori: I'd say short selling is exactly like borrowing money to buy stocks. Would you also ban leverage?

We have so many regulators we effectively have no regulation (but lotsa transaction costs).

Well put, except it's not true. As we're seeing now, the inefficiency introduced by regulations is more than compensated by the investor confidence resulting from a stable market.

We're going to spend hundreds of billions of dollars to save potentially trillions in losses. $100 million of regulation and oversight, applied at the right time, could have done the same.

V, good point, of course not but its not the same, you can use leverage to buy stocks and then also sell the same stocks, when you unload your position you create a down pressure on the price.

As we're seeing now, the inefficiency introduced by regulations is more than compensated by the investor confidence resulting from a stable market.

Are you sure it's not the other way around: a stable market resulting from investor confidence?

Because it looks like we have endless regulation and government intervention to sustain a delusion -- and once enough people buy into the delusion, everything works fine!

Or maybe we should just try something simpler: pass a law making it illegal for stock prices to go down.

Already been tried. In Pakistan. [Link]

Jason, they banned all short sales of those stocks (except for "certain bona fide market makers" and some option exercises). From http://www.sec.gov/rules/other/2008/34-58592.pdf:

IT IS ORDERED that, pursuant to our Section 12(k)(2) powers, all persons are prohibited from short selling any publicly traded securities of any Included Financial Firm.

V, Ori, and everyone else: In my recent post, I explain how you can synthesize short and long positions. You have to ban a lot more than short-selling to ban short-selling, and a lot more than margin-buying to ban leveraged longs.

Wow! Ban short selling for a few days and watch the logical fallicies fly!

I know this is off-topic, but I want to bring up a point, and I don't want to wait around for the next Open Thread.

Ever since I read about prediction markets on this blog, and I read The Wisdom of Crowds, I became interested in both. And I watched Intrade.

I've especially watched Intrade over the last month. But what I came to realize is that Intrade doesn't know anything that any of us, individually, would not know.

A month ago, Obama was leading in the polls, and predictably, he was leading on Intrade. Then McCain got the "Palin bounce", he led in the polls, and he led (just last Tuesday) on Intrade. The new polls came in, Obama led, and once again Obama is up on Intrade.

Remember about a year ago when Hillary Clinton shot up to ~70% on Intrade and Robin asked "what does Intrade know that we don't know?" Apparently nothing, because she lost.

I'm not saying that prediction markets or the wisdom of crowds are wrong. I'm just saying that Intrade is not large enough, or something is wrong with it, to the extent that it has repeatedly demonstrated itself not to have any more information than the rest of us have.

So. Who's going to win? I can look at the latest polls and that's just as informative as Intrade has been over the last year (other than it's erroneous bubbles). So much for that.

MZ, I disagree to a limited extent, for reasons I explained on my blog. I think Intrade may have specifically predicted McCain's temporary lead in the electoral college before a reasonable expert could (about 1 week in advance of its occurence). Being able to predict events accurately one week in advance is about as good as our best weather prediction. It's not trivial.

Eliezer, whatever you're doing here with this post, it's not enlightenment. In my opinion you're pretending to understanding that you don't have. It's not to say that you're position is wrong (I doubt either of us know enough to know conclusively), but that it's presented in an overreductionist, unhelpful way. Take the best arguments for the short-sell ban seriously (some of them seem to be presented in the comments here), I feel intellectually dirty after reading your post as written.

MZ, if you want to prove your claim, start creating a data series of your probabilities on these events, forecasts which you create independently of the market forecasts to which you want to compare. Then with enough data on your and market forecasts, we could evaluate their relative accuracy. Every time we've done that in the past the market has done at least as well as the the other forecast source.

"All selling of stocks should be banned. Once you buy a stock, you have to hold it forever."

You jest....but there are people seriously suggesting such in the UK at present. Even worse, they are people that serious organisations (like the TUC...for a given valur of "serious" obviously) listen to.

Arrgh!

"The capitalists are trying to save capitalism from the capitalists!"

Actually, if we didn't have fiat money that can be printed at will and interest rates were set by market forces and not a bunch of white men picked by the government, we wouldn't be in this mess.

"Actually, if we didn't have fiat money that can be printed at will"

What sort of currency system would that be? Like the current one, only it would be illegal for the executive to order the printing of more money than needed to replace worn out bills and coins? Or did you have something more radical in mind?

What sort of currency system would that be?

Is this some kind of joke? The vast majority of currency systems in history were non-fiat. You'd have to artificially restrict your knowledge of history to within the last fifty years to be unfamiliar with the concept and its associated prior manifestations.

I agree with Caledonian this time: pdf23's comment shows a lack of basic knowledge of money.

I think you guys misunderstand. I'm fully aware of bartering and "precious metal" style currency systems, but those are far, far from what we have now, and I wanted to know what specific implementation Michael had in mind. I'm not sure if my suggestion would qualify or not, but then I'm not offering myself as a financial expert either.

Are you making an argument in favour of anything?

Just to clarify, i am talking about naked shorting (common in the US), below from The Big Picture (Barry Ritholtz). You can still take a negative position in most papers using derivatives.The temporary ban is on short selling to help the markets heal somewhat (damage from aggressive short selling esp. naked short selling financials). Source: http://feedproxy.google.com/~r/TheBigPicture/~3/PS4hr_YMAeA/short-selling-b.html

"Earlier today, we looked at an October 18, 1930, NYT editorial on on Short Selling. As we now see via Google News, bad ideas are contagious:

• Germany restricts short selling of financials • Netherlands bans short-selling • Taiwan limits short-selling • Australian Regulator Extends Ban to 'Covered' Short Selling • Dutch ban 'naked' short selling for 3 months • Irish Stock Exchange moves to block short-selling • Dubai condemns short-selling of shares

And in related news: • Short-selling set to debut in Egypt as the West moves to curb it • CBOE Head Denounces SEC's Emergency Short-Selling Ban • Swedish not considering shorting ban

1930 editorial on short selling, sounding eerily similar to today, but, unfortunately, ultimately smarter. Hat tip to Brian Murphy (and, one just noted, the immediately preceeding comment).

I hereby dub the Paulson plan the Tulip Buyout.

I'm going to post this request at a number of econ blogs I read, in case others have suggestions.

I'm feeling, rather desperately, that we need a faster tool for critiquing and comparing the different proposals out there. I want a mechanism by which the experts can point out flaws in different solutions and arrive at an optimal selection (if not consensus). If this all has to happen in a week, the blogosphere needs to be even faster than usual.

Is there a site out there doing that now? Could wikipedia support this, or would the comment threading collapse under the weight? Other suggestions?

@Andrea

Um, think prediction market? Isn't Intrade already running contracts on bank failure & the bailout? But it seems like what you want is a policy market. . .in which case you've come to the right place. . .

@frelkins

That's why I posted here too. A policy market is closer, though there's an old system called crit.org that was designed to mimic the Ted Nelson model of layers of typed comments.

I just don't know what's out there now.

Now that the shorting ban is over, the question is did it work? Did it help? Or did it just power-drive the market even lower as traders abandoned longs they would have otherwise kept? And did really increase transaction costs by more than 40%?

Banning naked short-selling, which influences prices, is one way to avoid price fluctuation. Another is to ban price-influencing long-buying, which is also taking a position on the market. It remains a constant surprise to me that nobody has genuinely tried to make this illegal.

Thought: what's the difference between 'investing' in stocks and 'speculating' in stocks? Is this just another connotation question?