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Really, the temporary ban on shorting financial stocks was just a knee-jerk, stop-gap solution to stop the bleeding. The idea is that in a climate of intense fear, shorts can push stock prices below where they really belong. Luckily, this is a short cooling-off measure. It looks like the ban will be lifted Oct. 2, or about 2 weeks from now.

I know it's been mentioned here why short selling is productive in healthy markets, but let me try to explain it using a different analogy...

Let's say you are doing an analysis on Company X. If you really like the company and think it's undervalued, you look to profit on that by buying their stock. You have a strong incentive to find this positive information about X because if it's there, you can make boat-loads of money off of it through capital gains.

But what if you find the company overvalued? Even worse, you dig deeper and find questionable financial figures (like 30:1 leverage while buying subprime debt) and are confident that Company X is going to suffer in the near future. You can then short X and profit from this information. You have a strong incentive to find out this kind of information. Without shorting, you have no incentive to dig deeper. Once something questionable is discovered, you ignore the company, because there's nothing to be gained from it.

By shorting, you are adding a valuable piece of information to the market. You are announcing that you are confident in a stock fall, so confident that you're willing to pay ~10% interest plus the dividend rate while waiting for your thesis to play out. If there is a large short interest in a stock, it should be an instant red flag to anyone considering a long position.

In short (pun intended), it enables a more balanced look at any company. Without it, you can only display enthusiasm or apathy for a company. With shorting you can get pessimistic views as well, which allows you, John Q. Shareholder, to get a better representation of the market's sentiment.
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