August 12, 2011
The NYT had a piece on the decision of four European countries to ban short selling. One of the rationales was that traders were spreading negative rumors about banks and profiting from them by shorting their stocks. Insofar as this is happening, this is a form of market manipulation which is a violation of security laws everywhere.
In principle, regulators should be able to track down and punish manipulators, however as a practical matter manipulation will often be difficult to detect. It is possible that outlawing short sales for a period of time can prevent manipulation, but the real issue is manipulation not short sales. Manipulation also takes place on the upside (e.g. rumors of exaggerated corporate profits) and is every bit as harmful to the proper working of the market and the economy.
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