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Short Selling Band-Aid Stalls the Free Market Process


Short selling bans only serve to further erode confidence and create more fear.

While financial markets are not perfectly efficient all the time, stocks and indexes usually find their way to "natural" levels over time. Any temporary, artificial solutions aimed at calming volatility or boosting prices typically do little to achieve their goal. In fact, it's usually the opposite. Trying to manipulate the system usually only triggers more panic and skepticism.

QE2 is one example. The Fed attempted to support asset prices and trigger a "wealth effect" by what amounts to money printing. From the period since the Fed's Jackson Hole summit last fall when they made the decision to embark on another round of large-scale bond buying, the market enjoyed an impressive run.

David Tepper, in his well-documented early morning appearance on CNBC, was the most notable pundit arguing, "Why fight the Fed?" QE2 restored confidence in the market temporarily, but over the course of only a few trading days, all gains resulting from QE2 were wiped out in one feel swoop. The market finds its equilibrium naturally one way or another.

Back in late 2008, I made an appearance on CNBC in which Mark Haines and Bob Pisani asked my opinion on the short selling ban and circuit breaker idea, which is now in effect. I stated my opinion that while these measures may temporarily restore order, in the end of they would be doing a disservice to investors to try to put Band-Aids on a broken market. Short selling bans only serve to further erode confidence and create more fear. The question many people ask in that type of situation is: What happens when short selling is allowed again?

Similarly, over the course of the last couple years we have seen several instances where stocks were not allowed to find natural bottoms because of circuit breakers. The stock market is a land of supply and demand, and buyers will step in if a stock plunges significantly below "fair value." Delaying the inevitable only delays the process.

Now, in Europe, several countries are mulling a short sale ban, which I think is a bad idea. Again, it just makes me wonder: Is this situation even worse than we all think? Those who thought the worst of it was over and were considering stepping in to buy stocks at depressed levels are now likely thinking twice.

In this country as a whole, we need to stop searching for Band-Aids that kick the can down the road and instead face our problems head on. Focus on solutions to genuinely restore confidence in the system rather than creating an illusion of order. While I would never advocate for a default on US debt, I agree with many conservative politicians who are saying, "enough is enough." We need to start paying off our debts, balance the budget, stop causing massive commodity inflation, or the eventual "reversion to the mean" is going to even more harsh than anyone can currently comprehend. The US and China essentially both have a gun to each other's head, but there will come a day when China's gun will be a lot bigger.

Markets do not find bottoms in an orderly way, and trying to force the issue just creates more problems and fear. Real bottoms occur naturally, and give buyers confidence to step in.

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No positions in stocks mentioned.

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