11. Legal prohibitions.—Few operations have been more criticised than short selling. Laws have been passed prohibiting it, but these are not at present in operation, and the practice is now entirely legal. In Xew York State, the legislature passed a law, in 1812, declaring void any contracts for the sale of securities which the seller did not actually own or have in his possession at the time when the contract was made. Forty-six years later however, this section was re pealed and the following substitution was made: An agreement for the purchase, sale, transfer or delivery of a certificate or other evidence of debt, issued by the States or any state, or municipal or other corporation, or any share or interest in the stock of any bank, corporation or joint stock association, incorporated or organized under the laws of the United States, or of any state, is not void or voidable, because the vendor, at the time of making such con tract, is not the owner or possessor of the certificate or cer tificates, or of other evidence of debt, share or interest.
The fact that a short sale is effected thru a broker on margin does not operate to make the transaction illegal and the contract void. This fact has been up held by the courts again and again.
Judge Barnard, of the Circuit Court of the District of Columbia, commented upon this point as follows: A short sale is not a gambling operation. The law de fines a gambling operation to be where the parties make a contract of purchase and sale, without intent on the part of either, to deliver or receive the article which is the subject of the contract. .. . This is a mere bet—a gamble. But where actual delivery is made of the goods contracted to be sold and received, the transaction becomes a commercial one.
12. Functions of short selling.—As regards the ac tual effect of short selling, the weight of argument seems to be in its favor. The point is important from a practical standpoint, and has been hotly debated for more than one hundred years. The committee ap pointed by Governor Hughes of New York to investi gate conditions in Wall Street, reported on this sub j ect as follows: 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. In other words short selling tends to produce steadiness in prices, which is an advantage to the community. No other means of restraining unwar ranted marking up and down of prices has been suggested to us.
In justification of short selling, Professor S. S.
Huebner writes in the Annals of the American Acad emy of Political and Social Science: Short sellers do not determine prices. By selling they simply express judgment as to what prices will be in the fu ture. If their judgment is wrong, they will suffer the pen alty of being obliged to go into the market and buy the se curities at higher prices. Nine-tenths of the people are by nature "bulls," and the higher prices go, the more optimistic and elated they become. If it were not for a group of "short sellers" who resist an excessive inflation, it would be much easier than it is now to raise prices thru the roof ; and then when the inflation became apparent to all, the descent would be abrupt and likely unchecked until the basement was reached. The operations of the "bear," however, make ex cessive inflation extremely expensive and similarly tend to prevent a violent smash because the "bear," to realize his profits, must become a buyer.
The writer has been told by several members of the New York Exchange that they have seen days of panic when practically the only buyers who were taking the vast volume of securities dumped upon the Exchange, were those who had sold short, and who now turned buyers as the only way of closing their transactions. They were curious to know what would have happened in those panic days when every body wishes to sell and few cared to invest, if the buying power had depended solely upon the real investment of the outside public. . . . Short selling is thus a beneficial factor in steadying prices and obviating extreme fluctuations. Largely thru its action the discounting of serious depres sions does not take the form of a sudden shock or convulsion, but, instead, is spread out over a period of time, giving the actual holder of securities ample time to observe the situa tion and limit his loss before ruin results. In fact, there could be no organized market for securities worthy.of the name if there did not exist two sides, the "bull" and the "bear." The constant contest between their judgments is sure to give a much saner and truer level of prices than could otherwise exist.
13. Arguments against short selling.—Examining the case in more detail, and restating some of the ar guments noted by Professor Huebner, we find that three valid arguments against short selling present themselves: (a) It tends to depress prices.
(b) There is a temptation to keep on selling after prices have fallen. Short selling may be used to dis organize an already dangerous and panicky market.