Why Short Sellers Help Keep The Stock Market In Check: 'Pricing Mechanism Is Broken' Without Them

A stock buying frenzy by online groups of retail traders, led by Reddit’s WallStreetBets community, has triggered massive short squeezes in highly shorted stocks like GameStop Corp. GME, AMC Entertainment Holdings Inc AMC and others in recent weeks.

Many onlookers, such as influential Tesla Inc TSLA CEO Elon Musk, have praised the efforts to bring down institutional short sellers, while others have rushed in to defend short sellers as an important part of a healthy market.

“U can’t sell houses u don’t own, u can’t sell cars u don’t own but u *can* sell stock u don’t own!? This is bs – shorting is a scam legal only for vestigial reasons,” Musk said in a tweet last week.

Musk Calls Out Shorts: Musk has long been critical of short sellers, and has often publicly taunted David Einhorn and other Tesla shorts. Tesla is by far the most heavily shorted stock in the world, according to S3 Partners.

“Here come the shorty apologists...give them no respect...get Shorty,” Musk said.

On a recent edition of Benzinga's PreMarket Prep, co-host Dennis Dick took a few minutes to defend the role short sellers play in price discovery in a free market.

“Shorts are the pricing mechanism. It’s what keeps prices in line. It’s what provides liquidity to the market. Without shorts, you have no liquidity. Without shorts, you have stocks go up like GameStop,” Dick said.

Related Link: WallStreetBets Posters Warn Retail Traders On Silver Squeeze: 'The Antithesis Of Who We Are'

Recipe For Bubbles: Dick said removing short sellers from the market plants seeds for extreme market bubbles and elevated risk for investors.

“A lot of people get hurt in the end of this. We don’t know when the party ends, but it always does. So without shorts to keep prices in check, the pricing mechanism is broken,” Dick said.

Dick pointed out that regulators banned short selling on financial stocks for three weeks during the 2008 financial crisis, and the results weren't good.

“In those three weeks, the overall stock market fell 18%. Guess what the financials did? They fell 23%...All it did was increase volatility, and they fell more than then overall market.”

Carson Block's Take: Short seller Carson Block of Muddy Waters Research also stepped up to defend short sellers in an interview with Bloomberg TV this week.

"I believe at the end of the day, that the research that we produce has utility. It has led to eight delistings…and a case against tariff evasion," Block said.

Block said short sellers along with market regulators help sniff out fraud and deception in financial markets.

"Does research like this matter? Yeah, I think it does. From a social utility perspective, yes. But there's less social utility to it when the SEC isn't enforcing as heavily as it used to. So I like to think that under the new administration there's more social utility...kind of a counterweight to the extreme dishonestly that's surged through the market the past several years."

Benzinga's Take: Musk and other CEOs of public companies understandably dislike anyone who believes their companies' share prices are too high. However, the best defense against short sellers is a successful business, as Tesla has demonstrated in recent years.