Thursday, April 30, 2015

Should you be able to short internet Unicorns?

This article wonders if you should be able to short private internet stocks with (seemingly) excessive valuations:
Private tech companies could benefit from relaxing restrictions on stock transfers and allowing short-selling, bringing more investors into the market for their stock.
OK, so the summary is a little disingenuous, but more seriously, if someone thinks that a stock, public or private, is too high, then isn't the ability to short it both a good way for the market to capture that information and hopefully come up with a better valuation, and also getting naysayers to put-up or shut up? Also, aren't better valuations important for the economy as a whole, and the sector in particular?

I disagree with both assertions. Firstly, I don't believe that shorting is captured particularly well as market information. It didn't help with the Internet bubble of the 1990s, which is primarily a public market phenomenon, and it contributed to the real estate debt bubble that followed in the 2000s (by banks selling the securities with one hand specifically so they could short them with the other).

Secondly, I don't believe that asset bubbles in general, and this asset bubble in particular, are harmful to the broader economy. Unlike debt bubbles, which wipe out bank capital and so generate a systemic contagion effect, equity bubbles wipe out assets within individual entities, limiting their spread. We bounced back quickly from the crash of '98, but are still struggling with the crash of '08. Japan has yet to emerge from their crash of '91.

When/if this bubble pops, it will knock out some venture capital and private equity firms, will be a damper in a couple of overcooked real estate markets, but the broader economy will continue just fine. If you see stocks tumble, rush in to buy them.


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