- The German Short Sale Ban

Short sale bans don’t prevent assets from going down or increase available liquidity; in fact they do the exact opposite. But try telling that to a politician. People should remember this German short sale ban and its direct effect on an already troubled market. Everything even vaguely German is being sold aggressively by everyone, everywhere. Not out of vindictiveness as a leftists would surely have you believe but because the short sale ban limits the ability to effectively manage risks.

Liquidity is more of a problem for professional investors than volatility, but I think most retail investors don’t really understand that. If you had a billion dollars what would you do with it? Buy the S&P? If you submitted a market order for a billion dollars of the S&P the price would skyrocket until your order was filled and then fall again - effectively preventing you from making a profit any time soon. In reaction to that, markets have evolved to make it possible for investors to buy large amounts of assets without causing price distortion.

But when you eliminate short selling, you cut off a substantial portion of those tools making it impossible for large investors to participate. And rather than being legislatively forced into a long position, large investors will simply sell out until a 'normal' market resumes. But politicians, retail investors, and ‘experts’ from the internet chat rooms don’t believe that. They think the short sellers are evil and driven only by malice. This is silly and childish – exactly what I’ve come to expect from politicians of all stripes and leftists everywhere.

In my world however, short sellers are buyers when markets fall because they need to take profits. They are sellers when markets rise for no reason (like a dot.com or credit bubble) and prevent pricing from becoming excessive. In that way they provide price stability to markets during volatile times. They are a free market - market regulator. They make sure the valuations of assets are based on something real. They go a long way to preventing the kind of excesses that financial regulators try to prevent themselves.

So by all means let’s ban them immediately.

Whenever you set a lower limit on the stupidity of politicians and say “they can’t possibly be this idiotic” sure enough, some elected official somewhere manages to slip under the bar. This German short selling ban is so stupid, even the talking heads, fresh from the Leon Trotsky School of journalism and still smelling of smoke from burning Goldman Sachs employees as witches, are all agreeing with me. That is a pretty low bar.

In my world when pols ban short selling it sends a signal. It means that the short sellers are right but the pols don’t dare let the markets unwind naturally because it will mean their end. This German short selling ban is telling me that the Euro is in worse trouble than anyone realized. Up to now I’d have bet that things in Europe will eventually work out. Predictions of the apocalypse aside, things almost always do. It would have been painful and would have settled at a much lower level, but it would have worked out more or less peacefully.

But this is an important message. To the professional investor it says that Europe can’t handle the truth, and that means this may be the very end for the common currency.



%%%%UPDATE%%%%%

The specific effect of a short sale ban is always the same. First comes a small rally while shorts cover their now 'illegal' positions. Then the market will gently sell off over a longer period as longs slowly liquidate their holdings as well. As they do, the relative volatility of the affected markets will rise from lack of liquidity. In the end, the market will end up at a lower level, with a higher volatility than it was before the ban.