Complex Systems Institute: Free markets are a good thing but when they are too free they self-destruct (2009)

Market Failure: Interdependence in Action


YANEER BAR-YAM:
Mortgages are a good idea, but making them too easy to get, or too hard to get, is not. ... Free markets are a good thing, but when they are unregulated (too free) then markets self-destruct.
... There is a significant example in policies of today that may very well be contributing to the current crisis. The SEC supports policies enabling short selling because, among other things, it can help weed out the weak corporations and avoid market bubbles. This is fine as long as there aren't too many short sellers. Even a strong corporation can't survive if too many short sellers gang up on it. When there is an overabundance of short sellers, they kill off one company after another. Some people call short sellers predators, and the comparison may not be too farfetched.
Having a few predators to eliminate weak and sick animals may be good for the herd, but too many and you have an extinction.
In the current panicky conditions, the SEC has realized there is a problem and restricted shorting on financial stocks. So what should we expect the short sellers to do? Are they going to stop selling? No. They go where they can and short-sell non-financial stocks increasing the risk to the rest of the market. Protecting some of the herd makes the rest more vulnerable to predation. Things are not independent. If too much of anything is not good, how do we prevent it? Moderation is considered a personal virtue. Moderation is also an essential economic principle. What is bad for markets is when one player, or a coordinated group, controls the movement of prices. Regulations can restrict the extent of short selling, or rapid buying, rather than forbid or allow it.