In the fall of 2008, as the Financial Crisis was underway, short sellers were blamed for the sharp drop in the price of financial stocks and short selling was temporarily banned for a list if 779 stocks.
But, did short sellers deserve to be the “whipping boy”? Is short selling immoral?
First, let’s review what short selling is. In the stock market, if a trader feels that a stock is going to go down in price, he or she can capitalize on this view by borrowing shares through their broker, selling the shares, and then buying them back at a later time (hopefully at a lower price).
Short selling is also used by market makers to balance supply and demand in a stock, in order to maintain an orderly market.
In fact, this second use of short selling is seen as more “legitimate”, and caused exchanges, traders, and economists to be outraged about the short selling ban. They warned that the ban could disrupt the flow of the markets. Eventually, the SEC modified the ban to allow market makers to short stocks.
But, what about short selling as a way to make money from falling prices? Is this a legitimate activity? Many proponents say yes. They argue that “investors are best served when they can hear both the reasons to buy and reasons to sell any given security.”
In fact, there have been cases where short sellers, due to their “greed”, have served to police the market place.
For example, in 2005, the state of Ohio invested $ 50 million of pension money in shares of Greg Manning Auctions – which bought and sold rare coins and stamps. These shares took off after a majority stake was bought by a Spanish company called Afinsa Bienes Tangibles.
Short sellers suspected that Afinsa was a Ponzi scheme that was paying off new investors with old money. They shorted the stock of Manning Auctions and got a reporter with the Toledo (Ohio) Blade to investigate. The company ended up exposed, and the short sellers made money while also being credited with saving the pensions.