Comments on economics, mystery fiction, drama, and art.

Thursday, September 18, 2008

Time to Sell McCain Short?

So now, courtesy of ABC news, John McCain expresses his deep understanding of how financial markets work:

"McCain said the SEC has allowed trading practices such as short selling to stay in place that turned the "markets into a casino." "

A "short seller" borrows shares of stock from a third party, in order to sell them. (The short seller is "short"--does not currently own--the shares being sold.) The short seller then has to repay the shares of stock to the third party. If the share price falls, the short seller can buy the stock back for less than its selling price, and thereby makes a profit. If the share price rises, the short seller takes a loss, which can, conceiveably, be very large.

It's true that the short seller is, in a sense placing a bet that the share price will fall. But the buyer in this transaction is also placing a bet--that the share price will rise. Short sellers can in fact bring some discipline to markets, by expressing contrary opinions, and by putting their money on the line. (A put option is also a way of expressing your opinion that the share price will fall.) Short selling is already fairly heavily regulated (e.g., you can only short a stock when its price is rising; the broker through whom you are selling must confirm your ability to obtain the shares to settle the trade; etc.). Short sellers are also responsible for any dividends payable.

Short selling, you see, sounds bad--you're selling something you don't actually own. So it's easy to take an ill-considered shot at it. It's easy to allege that stock prices are being driven down by short sellers (and, yes, some short sellers do fabricate rumors designed to make their wishes come true). So short-selling must be predatory, or it must contain fraud.

But short selling is simply one of many ways of expressing--and backing--one's opinion about what's going to happen to share prices. So I think McCain's outrage is overdone, and I expect that his outrage is either faked, or a result of ignorance.


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