If Short-selling is Outlawed...

From the smart and clear-sighted Simon Johnson at Baseline Scenario:

Here’s the legal theory to keep in mind. Mr. Paulson only stood to gain on a massive scale (or at all) if the securities in question were mispriced, i.e., because their true nature (that they had been picked by Mr. Paulson) was not disclosed. In other words, the Paulson transactions at this stage of the game only made sense if they involved fraud (emphasis added).

If Simon means "some lawyer will argue this but I ain't buyin'," then okay. But if Simon buys it (and I am pretty sure that he does), then it is flat wrong. It is not true that the deals "only made sense if they involved fraud." They made sense if they involved fraud or if they involved a gargantuan self-delusion from which the Goldman execs (and the buyers) refused to recover.

There is, of course, a deep-seated core tension here--the ethics of entering into a transaction in which I know the other side is misled. If I buy a gewgaw from the guy at the street market knowing that it is a diamond, and knowing that the seller thinks it is just a rock, then maybe I ought to return it. Maybe, but maybe not. And as a forum for exploring these moral ambiguities, I hardly think Paulson's Wall Street is the right place to start.

I don't want to go overboard here. Simon says Paulson needs a good lawyer and no quarrel there. And it seems clear that the SEC has set about the task of mining the paper trail (in search of missives like this). But it's worth keeping in mind: short selling is not villainy. It is often the only island of sanity in a sea of mania.