A Man, a Plan, and a Short-Selling Ban
Yes, I invented the title but no, it is not a palindrome.
As usual, I wrote on a topic for different outlets, stressing different themes depending on the audience. EconLib is for super econ geeks, so I get fairly technical (at least by Internet standards) in this piece on the recent financial coup. For example:
Continuing the above logic, there are other firms that might use shorting as a hedge, rather than as a speculative move. In the extreme, suppose that an analyst is dead certain that Medium Bank XYZ behaved beautifully throughout the housing bubble, that there is not a single “toxic” mortgage-backed security on its balance sheet, and, moreover, that XYZ has been very careful to become intertwined only with other financial institutions that have played it safe. The analyst is convinced that Medium Bank XYZ is one of the safest banks out there.
Even so, it does not follow that the analyst will recommend buying large numbers of shares in XYZ. After all, it is a minor player, and if bad news about a regulatory change or some other event sweeps the market, then XYZ’s stock might go down with the herd. A much safer bet, therefore, would be the spread between XYZ and comparable financial stocks. For example, the analyst might recommend that clients take out a large long position on XYZ, while taking out much smaller short positions on the largest five banks. The SEC’s ban has now made this hedge illegal, and thus our hypothetical analyst may now recommend less aggressive buying of XYZ.
