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Short Sellers: Villains or Victims of 'Witch Hunt'?

POSTED: 12:47 PM ET, 09/19/2008 by The Editors

To the surprise of almost no one on Wall Street, the crisis in U.S. finance has poured gasoline on the always-smoldering fire of criticism against short sellers, investors who seek to profit when stocks plunge.

U.S. market regulators today issued an emergency ban on the short-selling of financial stocks. Yesterday, the U.K. Financial Services Authority imposed its own temporary four-month ban on shorting financial stocks. That was followed by similar moves in France, Portugal, and Ireland.

New York Attorney General Andrew Cuomo is vowing to investigate and prosecute illegal short selling, and European regulators are investigating similar allegations.

The practice of short-selling is generally legal: Investors borrow shares and then sell them, hoping to buy them back later when the price drops. They pocket the difference in price, when they guess right.

The nation's three biggest public pension funds in California and New York yesterday suspended lending stock of Morgan Stanley and Goldman Sachs Group Inc. to short sellers, after the shares of those two banks dropped dramatically.

Things heated up for the shorts this week when Morgan Stanley chief executive John Mack went on the offensive, blaming them for spreading false rumors that led to plunges in his bank's stock and threatened the company's ability to avoid the insolvency of the Lehman Brothers investment bank -- which declared bankruptcy on Monday. Other critics argued that the shorts were responsible for the troubles of insurance giant AIG, which had to be taken over by the government this week.

But cooler heads suggest that angry investors are looking for scapegoats for a much more complex crisis. They point out that short sellers are responsible for a relatively small portion of stock sales.

The Economist magazine opines that some of the actions against shorts seem to be an "alarmingly piecemeal" response to the overall crisis. Columnist Floyd Norris of the New York Times blogs, "The real problem is that financial companies got themselves in deep trouble with bad decisions. The short sellers who figured that out before the rest of us made money, but it is hard to believe the shares would not have come down anyway."

And a writer for British newspaper The Guardian suggests the executives are too quick to point the finger elsewhere: "The disease is the mismanagement of the banks' directors; short-selling is simply a symptom."

By The Editors |  September 19, 2008; 12:47 PM ET
Previous: Autopsy Labels Jail Death a Homicide | Next: Palin News Roundup


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Democrats for John McCain and Sarah Palin in 2008

Posted by: Jennifer | September 19, 2008 3:31 PM

I agree that the practice of selling short is only a small fraction of market sales, however it seems an oversimplification to suggest that selling short has such limited influence. Also, to suggest that selling short is an indication of overall value.

Selling short is a bastion of the irrational market, where hype and rumor are as (if not more) important than substance and value.

At times the market can be driven by irrational impulse as fear or euphoria spreads throughout, so it is not impossible to see a small number of traders gambling it all on short sales creating a downward draft that overwhelms the actual audited value of a stock. At the end of the day stocks are businesses not lotteries, and they should not be left to the whim of self interested traders trying to make a buck off of pushing them to unnaturally low levels, any more than they should be allowed to be pushed to unnaturally high levels.

Posted by: g | September 19, 2008 4:40 PM

Conservatives were outraged about the time-bomb Clinton placed in the economy in 1995 with the new mortgage regulations. Bush tried to fix this in 2003. The Republicans tried to fix this in 2005. They were blocked by Schumer, Dodd and Frank. This is not politics it's fact. You can't give loans to people who can't pay it back without repercussions. The time-bomb has exploded. Heads should roll.

Posted by: Ralph | September 20, 2008 12:41 AM

George Bush actions, jointly with Bernnake and Paulson enhances Hugo Chavez attitude in Venezuela and Latin America. Socialism is now stronger than ever. Wall Street Free market Capitalism is dead.

Bush should eliminate the embargo to Cuba and stop his rethoric of democracy, when he favors a few and harms the vast majority. A global financial crisis has not been prevented, only delayed. Investors should pull their money out of the market and place it under the mattress, or take their money to Latin American banks where there are tighter controls and vigilant eyes over corrupt bankers.

Posted by: PDS | September 20, 2008 10:25 AM

Concerning PDS comment (september 20,2008) it is not true that in Latin American banks there are tighter controls and vigilant eyes over corrupt bankers, I think it´s the opposite, in Latin America we have no confidence in banks, take the Venezuelan case, for example, where the whole bank system is a time-bomb.

Posted by: FranciaCordido | September 20, 2008 1:35 PM

This is a balanced and well-reasoned article. Beware: those jumping on a bandwagon to scapegoat others as long as their own goat is saved are likely the bigger part of the over-valued, greed driven, regulations-down frenzy which of its own ponzi-schemed weight has collapsed the value that should have accrued to the many small investors who are now the taxpayers raped by the big government-backed profiteers. Why is this administration so eager to rescue corrupt practioners of a market they manipulated so outrageously?? We have to ask, with so many losing so much in value, who are the scam "winners", the profiteers who created the ice-sculpture instruments that they used and sold to transfer this wealth to themselves? It is not only irony, that in removing protections established as a result of the market collapse of the Great Depression, we now witness the same collapse. Maybe bigger, if not forestalled now by government throwing its cost on the backs of working Americans and small investors. So instead of the sharks eating each other, we are the fish devoured in another great redistribution of wealth to the top.

Posted by: wjw | September 20, 2008 2:01 PM

If anyone wants a well-researched answer to this intertwined Hedge Fund-Banking-Mortgage-Insurance scandal and swindle, your local bookstore has it under the name, David Cates Johnston, FREE LUNCH, published by the Penguin Group. The crimes are exposed here. And the Bush Administration, the Federal Reserve, the SEC, the and the Congress must hold the criminals accountable. No More Bailouts !

Posted by: Eli | September 20, 2008 6:45 PM

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