Short-Sellers Keep Prices Honest?

Alex Singleton takes up the cause of unloved short-sellers, most recently criticised by the Archbishop of Canterbury, Dr Rowan Williams, and Archbishop of York Dr John Sentamu.

"Short-selling is a morally virtuous activity because it helps keep share prices honest," says Singleton.

His argument goes something like this: the stockmarket is a "big debating chamber" where company values are accurately assessed in terms of their return potential -- those deemed the best bets get investment and contribute to wider economic prosperity.

Short-sellers provide a "counterbalance" to long-term investors, who might be incentivised to paper over problems in favour of longer-term returns. "They [short-sellers] give a financial incentive to tell the truth about companies and help push the prices down to a more accurate level."

Spreading false rumours that drive down a share price is, he admits, unethical -- but claims over-valuation is just as prevalent.

The morality argument doesn't add up for me. But Singleton's not alone in championing short-sellers. Defenders argue they are quick to spot over-valued assets and therefore market malfeasance (Greenlight Capital's David Einhorn questioned Lehman Brothers well before its demise), with Jim Chanos of Kynikos Associates credited with raising awkward questions about Enron.

But how helpful are they in addressing the underlying cause of over-valuations? And how instrumental are they in pushing down good stocks? Defenders say that only naked shorting, when the short-seller doesn't even bother to take on the stock, is worthy of banning, and complain that short-selllers have been market scapegoats since the 17th century.

But where defenders argue they add liquidity, detractors see in their actions a venality that takes no notice of the wider impact on the economy and results in dangerous volatility.

That leads to the kind of panic that necessitated the FSA ban on shorting financial stock in the UK -- if only to stop rampant speculation and quell public fears that HBOS was about to implode. The FSA has (thus far) resisted pleas from non-financial firms wanting protection from short sellers -- despite those who question why some are protected while others aren't.

Whatever your views, fans and foes of short-selling believe the ban is going to change business dealings significantly. But is that such a bad thing?