Short Selling and the Great Depression: Echoes

In the midst of the Great Depression, people who bet on stock-market declines were considered unpleasant, unwanted, un-American, un-something. Yet as a New York Times writer noted in February 1932, "The bearish speculator is not often reviled in healthy markets; it is when prices are declining that opprobrium is heaped upon him."

Short-selling transactions involve a broker "lending" equity shares to an investor, who pledges to return them at a later date. Usually, the broker sells the shares, credits the investor's account, then waits for the investor to repurchase and return them. If the buyback price is lower, the account balance, less fees and interest, represents profit; if the price is higher, the investor adds funds and takes a loss. Short sales can yield big gains when markets collapse, but analysts have long debated whether they accelerate price slides or instead help establish "fundamental" values after a bubble.

With stock prices still discouraging in early 1932 -- with every upward movement seemingly followed by another slide -- a House subcommittee began hearing testimony about "bear raids," or traders driving down a target stock through extensive shorting, perhaps helped by fabricated rumors.

The governors of the New York Stock Exchange took preventive action on Feb.18. As borrowing investor-owned shares held by brokers was the crucial step in short selling, the exchange ruled that after April 1, share lending could be done only with the owners’ written permission.

The subcommittee’s chairman, Democrat Henry Tucker of Virginia, was unconvinced by this rule: "My opinion is that if an evil exists, it should be prohibited by law not by the perpetrators," he said, according to the New York Times.

At a press conference, President Herbert Hoover announced that he had spoken earlier with the exchange's president, Richard Whitney, and demanded a curb. He said: "The managers of the exchange should take adequate measures to protect investors from artificial depression of the price of securities for speculative profit. Individuals who use the facilities of the exchange for such purposes are not contributing to the recovery."

Financial historians soon pointed out that shorting had been blamed for price declines at least as far back as 1610, when the Dutch East India Company's value plummeted and the Amsterdam Bourse banned the practice.

Whitney promptly traveled to Washington to defend shorting. "If there had been no short selling," he told the subcommittee, "I am confident that the stock exchange would have been forced to close many months ago." After delivering a 12,000-word statement, he pledged to resign "if government regulation should take place."

The exchange's new rules, he added, didn't aim to correct prior abuses, for there were none. "We merely tried to clarify what seemed to be a confusion in the minds of a great many people."

When Whitney related an old adage, "Short sellers never die rich," Representative Fiorello LaGuardia, a Republican of New York, replied: "But since 1929, we haven’t had any short sellers in the bread lines."

The humorist Will Rogers added that if the exchange closed, "at least 115,000,000 of the 120,000,000 Americans would put on a celebration that would make Armistice Days look like a wake."

Still, none of the proposed bills to curtail short selling reached Hoover’s desk.

(Philip Scranton is a Board of Governors professor of the History of Industry and Technology at the University of Rutgers at Camden and the editor-in-chief of Enterprise and Society. He writes "This Week in the Great Depression" for the Echoes blog. The opinions expressed are his own.)

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