Any trader would know that in order to kill a stock , you kill a company by spreading bad rumours. Short-sellers will then drive down the stock prices-faster and harder- that is already weakened by fear and confusion, making it self-fulfilling and thereby killing the very last means of survival-selling shares to raise capital.
The regulator has the duty to protect the stockholders of the companies when the shares are listed in his exchange. He has the obligation to control, maintain an orderly function and prevent any abusive buying or selling of the shares. By the way, has the stock exchange been granted permission by the Board of the company for allowing short-selling of their common shares? If the answer is yes, then I don't think anyone would want to invest in such a company. If the answer is no, then why is the regulator encouraging it?
From another perspective, does naked short-sellers have a right to sell a piece of ownership of a company that they don't have? It must be remembered that stock-ownership is a legal piece of an entitlement to the rights of a business. Naked short-selling means you are selling something that you do not legally own and therefore, should be an offence. Otherwise, anyone can just go to the street and starts selling your house- "betting that the property market will go down"!
Strictly speaking, ban of short-selling does not neccesarily mean ban-of-selling and therefore, do not constitute to an end of a free market. The free market is still open to participants for them to buy and sell. Investors are encouraged to sell their shares if they think is over-valued or for any other reasons. However, abusive short-selling will create excessive liquidity (liquidity that is out of nowhere) and that will trigger margins call and that will turn out to become a deadly vicious cycle. I must say the regulator must have forgotten the lessons that we have learnt during the Asian financial crisis.
Consider this example, someone operates a store selling some goods. On his balance sheets, he has some stocks as his inventories, some cash in his cash register and bank account, some accounts payables for stocks and rents and stuffs like that. Business is brisk and cashflows is good. So everything will be normal. If someone wants to buy his store at a huge discount, all he needs to do is to spread some rumours. Rumours that will chase his customers away and bring his creditors knocking on his doors. Eventually, that will kill his cashflows and his business will be on fire sale.
This exactly what happened to Bear Stearns and Lehman. Did you notice that Lehman's crisis only happened after the SEC removed the ban of short-selling and uptick rule? If short-selling is not allowed, then there will be no reason or incentive for the short-sellers to spread rumours to drive down the stock prices for their personal gain! I do not dispute the fact that AIG has a lot of liabilites, but we must also recognise the fact that AIG has lots of wonderful assets. In a normal course of business, AIG could have easily disposed some of its assets, or sell some shares, or go to the bank to raise cash to meet its liablilites.
Finally, the other flaw in the current financial system is the "mark-to-market" accounting practice. For example, if someone in your neighbourhood sells his house for $50,000 when its worth $100,000 all the rest of the homeowners get hit. The bank will demand you to top-up the difference of the equity value, failing which, he will foreclose your house and sell in the open market creating another deadly vicious cycle. For this reason. market manipulators are able to mark assets at distress prices so that the whole portfolio of assets becomes unquantifiable.
In a nutshell, the stock exchange or its regulator has over-extended its rights as an operator and failed to protect the interest of the stakeholders and the investment community. The stock exchange has become worse than a casino (you can't manipulate in casino) and the invest-for-retirement theory does not work anymore.
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