Bloomberg News just announced that the SEC is talking about bringing back the Uptick Rule, which prevents people from shortselling while the stock is on its way down. I don't understand why the Commission doesn't focus on something more effective, like installing lavish statues of Mammon on trading floors so that traders can better propitiate him.
Every time markets fall, people start looking for a hidden villain, and short sellers are often a convenient target. We are not, after all, overfond of people who make their living by betting against other peoples' success. But shorts actually provide a valuable service: they make market prices more efficient, by pricing in the shorts' expectations that prices will fall. There are two determinants of a stock's price: where people are willing to sell, and where they are willing to buy. Because a short is more willing to drop the price at which he sells than someone who is long the stock and would have to take a loss, they help more quickly drive the price down to the level at which there are willing buyers.
Without them, market prices would be too optimistic--which sounds great if you're a corporate executive, but also means that your return on the stocks you bought would be, on average, lower, since the long term value of a stock has to roughly track its future cash flows. Moreover, there's little evidence that short selling on the downtick can cause death spirals in stock prices; death spirals tend to follow bad, bad news about the stock, not ambitious shorting.
But the SEC needs to be seen
DOING SOMETHING, and what better to do than to go after the
much-unloved short sellers? If you want to know what's actually
driving prices down, however, don't look at short sellers; look at this
graph, courtesy of Clusterstock: