Best Way to Curb Irrational Exurberance?

Zachary Goldfarb, a Washington Post staff writer, discusses (p. A10, “SEC Moves to Limit Short Sales of Stocks”) this SEC proposal – sympathetically.  The article is naïve – buying the complaint of “High-profile Wall Street executives” that short sellers “played an outsized role in crashing the stock values of several major financial services companies.”  Now, it is certainly true that when an asset value is falling, some will anticipate further declines and sell short – just as many will anticipate that an asset whose values are rising will rise further and buy long.

But in politics, as elsewhere, while success has a thousand fathers, losses are orphans.  Thus, many clamor for curbs on short selling, but there are few calling for curbs on those betting on things still going up.  That is we critique irrational exurberance but we penalize only rational prudence.  The story betrays this bias wonderfully in a telling quote: “The SEC [proposed rules are]… making it more difficult for speculators to pounce on a stock when it is already declining sharply.”  (italitics mine).

Imagine SEC rules designed to make it more difficult for speculators to pounce on a stock when it is already increasing sharply!

When markets boom, politicans take credit.  When markets tank, politicians blame the speculators.  Unfortunately, this bias means that Congress may further cripple the market’s ability to stabilize, to ensure that all information positive as well as negative reaches the market price.  Suppressing information is a bad deal – in civil societies and in the market.