22 November 2017

Short selling

A correspondent asks whether short selling will work against the Social Policy Bond concept. Specifically: if Conflict Reduction Bonds are issued, would short sellers profit from events that would make peace less likely?

Short selling in this context would be the selling of Conflict Reduction Bonds that are not currently owned, in the hope that their market price will fall, and that the seller will buy the bonds at their lower price. Short sellers could then be motivated to foment conflict.

I have these responses:

(1) The short seller doesn't own the bonds, but has to borrow the bonds from the broker or dealer when placing the sell order. The seller is then obliged to buy back the bonds at some point in the future. Just as the seller will want to see the value of the bonds fall, so the broker or dealer will want to see their value rise. In the Conflict Reduction Bond example, any additional incentive to foment conflict on the part of the seller would be balanced by an incentive on the part of the broker to reduce conflict.

(2) The weight of money - that is, the funds for the bonds' redemption - will be in favour of progress toward the goal; just as in the share market, the short selling of a company's shares doesn't change the incentives for the company itself to succeed. It's likely that any profits from short selling will be short term in nature; the long arc of the market for the bonds will bend in our favour.

(3) Public opprobrium. While people or corporations do profit from the failure to achieve social goals, they do so in ways that are indirect. If short sellers were to work to make social goals less achievable, the source of their activity and the reasons for it would be direct and identifiable. Taking the Conflict Reduction Bond example, again, weapons manufacturers and military contractors do already profit from their activities. They could even now be deliberately fomenting conflict with the aim of boosting their revenue. Short selling would be only one more way of profiting from war, but it is one that is both more identifiable and more likely to attract public opprobrium than any other so, even if a corporation were that way inclined, it would be unlikely to follow through.

Social Policy Bonds are not a Utopian solution but (in my view) they are much better than the current system. They would bring about the re-jigging the incentives to reward the outcome we want, rather than the activities, institutions or policies ostensibly trying to achieve it.

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