When someone predicts imminent financial doom, economists almost always taunt him, "If you're right, why don't you sell short?" If recent events prove anything, it's that short-selling is easier said than done. If we wanted advance warning of financial troubles, we'd be making short-selling easier. So what do regulators do? The opposite, of course!
The Securities and Exchange Commission on Friday issued a temporary ban on short sales of 799 financial stocks, a move against traders who have sought to profit from the financial crisis by betting against bank shares.
The S.E.C. said the “temporary emergency action” would “protect the integrity and quality of the securities market and strengthen investor confidence.”
This is straight out of my book. Popular pressure leads regulators to make market failures worse:
Even among economists, market-oriented policy prescriptions are often seen as too dogmatic, too unwilling to take the flaws of the free market into account. Many prefer a more "sophisticated" position: Since we have already belabored the advantages of markets, let us not forget to emphasize the benefits of government intervention. I claim that the qualification needs qualification: Before we emphasize the benefits of government intervention, let us distinguish intervention designed by a well-intentioned economist from intervention that appeals to non-economists, and reflect that the latter predominate.
If we really wanted advance warning (and a chance to mitigate) the next financial crisis, we wouldn't be banning short-selling; we'd be legalizing insider trading.