The SEC Wants to Ban Reality
Ned Ludd founded an eponymous movement in 19th century England meant to ban the mechanized looms that made the work of skilled textile artisans superfluous. According to the Luddites, the advances in textile technology operated by lower-skilled workers would put the skilled out of work, with some kind of “race to the bottom” the logical next step.
Thankfully the classical economists of the period had answers to the impoverishing views held by those fearful of progress. J.S. Mill noted that wind and water were but two natural variations of the loom that took the place of human exertion, while Fredric Bastiat made the simple point that “to curse machines is to curse the human mind!” If machines that served as human substitutes were truly impoverishing, then why were the advanced societies so rich relative to the poverty experienced by societies lacking progress?
As it turns out, the century that ensued was very much England’s when it came to economic prominence. Though the loom did destroy jobs, the capital that was freed up of the human and financial variety found new, economy enriching wants, and England grew. This was a happy result that has always revealed itself within mostly free economies.
Had the Luddites succeeded in blocking out economic realities back then, history today would be very different given the basic truth that England would have regressed. Instead, England embraced economic progress to the massive benefit of its citizens, not to mention the citizens of the world who benefitted from the investment that flowed from the world’s richest country.
All of which brings us to the SEC’s decision last week to ban the short sale of shares issued by 799 companies. As one would expect, the number as of this writing has risen to 900 firms whose shares can no longer be sold short. In what is America’s “everyone gets a trophy” economy, if firms don’t like the opinion of certain investors, they can go to the government and have those bears banned.
The absurdity of the SEC’s ruling would be hard to overstate. While there are many logical equivalents to this most ridiculous new rule, let’s just say that if the SEC can ban bears, than it can in theory ban bulls in a more optimistic market for ignoring certain companies in the midst of their buying lust. That, or investors who might miss out on a future bull market could lobby for rules against long buys as a way of enabling their purchase of shares at a discount to their actual value.
Put simply, if the SEC possesses the power to theoretically block out negative information, it can also impose rules that would retard the process by which positive information would reach the markets through heavy buying.
The logical response to the above is that no regulatory body would ever do such a thing. Maybe so, but it says here that any efforts to ban negative sentiment from seeping into share prices is a huge market negative; one that by definition is a ban on positive news.
That is so because to the extent that short sales drive down the prices of certain stocks, this is wonderful information that insures the process whereby capital is taken from the firms thought to be misusing it, and invested in those thought to be taking better care. The basic reality is that today’s market winners won’t necessarily be tomorrow’s, so if short sales are banned to the alleged benefit of certain companies, there will be other, potentially more vibrant companies of the future that will miss out on the capital that would reach them in a free market.
Think of it in terms of market laggards such as GM, Blockbuster and Circuit City. Absent the ability of short sellers to influence a fall in their respective share prices, existing shareholders would have very little reason to sell all three and place the capital with better management. To the extent that short sellers have impacted the decline of all three firms, it’s been all to the good for capital being moved in the direction of management less likely to destroy it.
More important, it’s quite simply not true that heavily shorted companies don’t benefit from the actions of short sellers. Much as a restaurant might change its menu if customers were few, so are short sellers a welcome message to company management that they’re misusing the capital entrusted to them. Just as the U.S. economy would be a mess absent price signals, so will the economy be much worse off if investors are blocked from communicating their displeasure through share prices to management.
On the positive front, any efforts to ban short sales will ultimately fail. Sure enough, early Monday morning the SEC partially reversed its ruling for market makers of stocks that are engaged in hedging activity. Indeed, it would be very risky for a firm to write derivative contracts on shares absent the ability to short. And if the ban hadn’t been lifted, other, more rational stock exchanges the world over would have gladly take business driven away by silly regulation: think Sarbanes-Oxley and the resulting globalization of IPOs.
What’s in the end most sad about the SEC’s ban is that it serves as yet another signal of what an unserious country we’ve become. The Luddites would be impressed. Rather than acting as economic leaders should in terms of elevating free trade, market discipline and price signals, we’ve shown amid a decline largely caused by our federal minders that we merely talk a good game about free markets.
Because when it comes to actually allowing markets to prevail, our leaders engage in rank hypocrisy of the kind which says, “Do as we say, not as we do.”