With trade depression continuing in spite of recent assurances that it would surely end with arrival of Autumn, and with the stock market also falling below the prices reached in last Summer's drastic downward readjustment, it was not perhaps surprising that search for something peculiar and abnormal in the way of cause should have begun. The average man does not apply severe logic in his reasoning on such matters. It was at least a convenient supposition that business must be hesitating because of the bad stock market, and Wall Street itself had been reporting, every day, that "bear selling" had emphasized the market's unsettlement. Hence the demand from irritated watchers of the situation that the evil influence of such stock market operations be ended by suspension or outright prohibition of "short sales."
Such action is undoubtedly possible. Mr. Untermeyer correctly states that the Stock Exchange itself "has it within its power to prevent or restrict short selling." Yet even so hostile a critic as he has heretofore been of Stock Exchange machinery is careful to add that whether such action would be advisable "is quite another thing." The stock Exchange authorities have given public warning that the speculative seller of stocks whose purposes were shown by deliberate circulation of disturbing rumors would be severely disciplined. But they too have declared through their president that since "normal short selling is an essential part of a free market for securities," prohibition of such sales "might result in the destruction of the market," and would therefore, in any case "too high a price to pay for the elimination of the few who abuse this legitimate practice."President Hoover lately talked the matter over with the Stock Exchange authorities; but the White House version of the interview was careful to point out that the Government had no idea of interfering with policies of the Stock Exchange.
Why this unanimity of attitude against the prevention of "short selling"? The answer of any one familiar with markets probably would be that, so long as stock market valuations can be influenced on the side of rising prices by speculative buying conducted with borrowed money, equilibrium is impossible except through permitting sales conducted through deliveries made with borrowed stock. Either practice is open to abuse, which it is the duty of the Exchange authorities to restrain. The abuse of "bidding up the market" by speculation based on broker's loans is not often recognized by the public, though its evil results ought to be reasonably evident to any one who remembers 1929. Yet it is plainly impossible to abolish "buying on margin" unless by reducing all transactions to a basis of cash purchases -- which would preclude an immense part of legitimate investment business. This being true, it ought to be evident that prohibition of "short sales" would expose the market to the extreme and dangerous maladjustment which so one-side d a proviso would inevitably create. Our "rashes" would be vastly more ruinous; our recoveries with the necessary "bear repurchases" eliminated, far less emphatic. The market would have become a trap for the unwary, with no automatic safeguard.
This is not the first occasion on which "suppression of bear sales" has been vehemently urged. After the panic of 1907, under circumstances closely resembling those which now exist, demands for such action forced Governor HUGHES to appoint an impartial committee to investigate the question. This committee contained not one member of the Stock exchange; it was made up of such eminent economists, journalists, and practical business men as Mr. Horace White, Judge Samuel H. Ordway, Mr. Edward D. Page and its professor John B. Clark of Columbia.
In its unanimous report of 1909 the committee found that the greatest evil of the stock market was "pyramiding" of speculation for the rise on the basis of previous paper profits, now used as "margin" for still larger ventures.
Of "bear operations" it had this to say:
We have been strongly urged to advise the prohibition or limitation of short sales, not only on the theory that it is wrong to agree to sell what one does not possess, but that such sales reduce the market price of the securities involved. We do not think that it is wrong to agree to sell something that one does not now possess but expects to obtain later. Contracts and agreements to sell, and deliver in the future, property which one does not possess at the time of the contract are common in all kinds of business. The man who has "sold short" must some day buy in order to return the stock which he has borrowed to make the short sales. Short sellers endeavor to select times when prices seem high in order to sell, and times when prices seem low in order to buy, their action in both cases serving to lessen advances and diminish declines of price.