Monday, August 11, 2008

Short-Sale Restrictions Are an Exercise in Naked Power (Bob Murphy)

Bob Murphy on the much maligned practice of "naked" short selling:

On July 29, the SEC announced that it would extend its original 10-day restriction on "naked" short sales of 19 major financial companies through August 12. Analysts across the board agree that this particular SEC rule, by itself, will have little effect except to raise transaction costs for those wishing to short Fannie Mae, Freddie Mac, Goldman Sachs, JP Morgan, and other powerhouses.

However, in conjunction with the Fed's recent lending operations to investment banks and Fannie and Freddie, the restriction on naked short sales makes perfect sense as part of a process of getting the public used to federal/private partnerships that would have been unthinkable before the credit crisis — especially from a "laissez-faire" administration.

In this article, I'll explain short selling (and the "naked" variant), its benefits to the market economy, and the harm from arbitrary government restrictions on the activity. I'll close by speculating on the possible motivation for the government to engage in an apparently pointless gesture.

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