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Home Publications Blogs Beat the Press What's the Moral Argument Against Shorting Stock?

What's the Moral Argument Against Shorting Stock?

Friday, 19 August 2011 04:51

The NYT featured an extraordinary comment by a Merrill Lynch strategist in an article on how the wealthy are often able to make money in a period of market volatility:

"There seems to be a moral argument against shorting, but from a purely practical point of view it leaves (hedge funds) in a better position to manage volatility."

It would have been interesting to know what the moral argument is against shorting. When an investor shorts a stock they are betting that it is over-valued, just as when they buy a stock they are betting that it is under-valued. In both cases, in principle the investor stands to lose their own money if they are wrong, but they are giving information to the markets and helping to appropriately direct capital if they are right.

If a company's stock is over-valued, then it benefits the economy to drive the price down so that it will be more difficult for it to raise capital in the future. In the standard economic story, this would mean that more capital will be available for corporations that have more growth potential. The loss of wealth by the company's shareholders would also free up resources to be used elsewhere in the economy.

In short, there is symmetry between buying and shorting a stock. There is no obvious reason that one act would be viewed as more or less moral than the other.

Comments (11)Add Comment
Does Baker Even Understand What a Trade-Off Is?, Low-rated comment [Show]
think blankfein
written by frankenduf, August 19, 2011 8:58
well, the argument would be that the shorting market disproportionately favors corruption, or inside trading- it is a fact that the market is 'marketed' to smaller investors in a biased way (buy, buy, buy v 1 hold v never sell)- this is the underpinning of the 'market making' that the banks so cynically defended themselves when it was exposed that they were fraudulently creating junk securities for sale, while shorting the same- rather than an aberration, this is a microcosm of 'marketeering' towards small investors- flood the market airwaves with false positive news, biasing buying over shorting, so that when the stock hits the fan, inside traders will disproportionatley be able to bail out while more smaller fish are left holding the bag
People buy only when stocks are undervalued? News to me.
written by BH in MA, August 19, 2011 9:35
People short stock because they think it's overvalued and is likely to drop in the near term. People buy when stocks are undervalued, yes, but they also buy when stocks are fairly valued and when they are obviously overvalued. They buy because they think the price is going to go higher.
written by skeptonomist, August 19, 2011 9:49
Hedge funds do not use shorting to "manage volatility" or actually reduce risk, they combine short and long trading to take big profits out of markets. There is a potential for catastrophic failure in this, as in any operation involving high leverage. Shorting itself is not necessarily bad, the problem comes when it is used in schemes to magnify leverage.
written by denim, August 19, 2011 9:55
Moral? It is bad economics. Shorting a stock is borrowing the stock and selling it for cash. That is taking money out of the market. Nobody is required to ever invest that money in the market again. It can be hoarded. And in a panic, as is going on now, hoarding is likely. So shorting is very bad economics.
Uptick rule?
written by Scott ffolliott, August 19, 2011 10:35
Is the uptick rule still in effect?

How are small individual investors protected in the placement of their sell orders?
Shorting and manipulation are not the same
written by Dean, August 19, 2011 2:23
folks have noted examples of people using shorts to manipulate the market. This is of course immoral, just as taking a long position to manipulate the market is. I don't know if the former is more common than the latter, but it is certainly the case that a higher percent of shorts fall in this category, since little guys don't short and only big guys can manipulate the market.

But, this is an issue of market manipulation, not shorting. I just don't see why an honest short would by any better or worse than an honest long position. If an investor believes that an asset is over-valued and is prepared to put her money on the line, what's the problem?
Shorting Adds Liquidity
written by Bruce Wilder, August 19, 2011 5:35
I don't know why some other commenters think that shorting a stock deprives the market of liquidity. Someone shorting a stock has borrowed a share, sold it, and is committed to purchasing a share in the future, to re-pay the borrowed share. The committment to purchase in the future actually adds liquidity to the market.

Now, that describes a classic, and fully legal, short. There are other ways to do it, which may not benefit market liquidity. In the housing bust, several hedge funds rather famously came up with methods of shorting, which actually magnified the housing bubble in its last stages, making everything worse. They injected false information into the formation of market price. That's a problem, closely associated with some kinds of derivatives, which seem to offload risk in ways, that may deprive markets of information, and adversely affect price formation.
The moral argument
written by Lord, August 20, 2011 8:37
is that the only way the short makes money is if someone else, the long, loses it. But they only lose it if they sell (or the company fails), and while it may be unfortunate to lose money, being able to sell when they need to is still a benefit.
Short vs. Long
written by John, August 23, 2011 1:21
The standard long practice is to purchase, hoping the price goes up. The standard short practice is to borrow stock and sell it hoping price goes down.

The complementary long practice is to buy on margin, borrow money to purchase the stock.
Colorado Rockies
written by Colorado Rockies, August 26, 2011 9:37

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.