During a short squeeze, assets are "mispriced," and their prices have high volatility. Having a "correct" and "stable" price for assets is fundamentally important to any market as the market's intended purposes are to allow society to "efficiently" allocate capital and let participants hedge risk. "Wrong" and highly variable prices inhibit both goals.
Of course short squeezes (like any asset mispricing) can be good for individual market participants: but on net for all participants, they are not. That's why regulators step in when assets are mispriced, and they have attempted to/successfully prosecuted those who have intentionally created short squeezes.
If we are going to call exchange-traded equities "mispriced," then I think it's fair to say that the mispricing exists prior to a short squeeze, when the stock is compressed by the price impact of the short seller.
> their prices have high volatility.
Volatility is not necessarily bad for markets.
> Having a "correct" and "stable" price for assets is fundamentally important
Stable prices require sources of potential energy like highly levered shorts to be dispelled, which only happens when the short covers. Also, unless you can walk on water you're not in a position to tell the market that one price is "correct" and another is not. The price is the price.
> the market's intended purposes are to allow society to "efficiently" allocate capital and let participants hedge risk
The market's purpose is to connect buyers and sellers in a way that allows them to get the best price in the world for a particular security at a given time. It has nothing to do with allocating capital in society, nor is it a hedging vehicle.
> "Wrong" and highly variable prices inhibit both goals.
If the price is wrong, go sell it. Also, prices vary because market participants react to changes in information. If the information is hot -- such as the emergent fact that sizable investors have found themselves in a tenuous short position -- then the price action will likely be hot as well.
> Of course short squeezes (like any asset mispricing) can be good for individual market participants
You're shifting my diction. Squeezes are good for shareholders and good for the company. The only entity for whom they are categorically bad is the poor sap who is covering the stock.
> That's why regulators step in when assets are mispriced
Regulators don't decide what an equity's price should be. Market participants do. Regulators have manipulated asset prices in the past and generally it doesn't end well. As Grantham puts it [0]:
All bubbles end with near universal acceptance that the current one will not end yet…because. Because in 1929 the economy had clicked into “a permanently high plateau”; because Greenspan’s Fed in 2000 was predicting an enduring improvement in productivity and was pledging its loyalty (or moral hazard) to the stock market; because Bernanke believed in 2006 that “U.S. house prices merely reflect a strong U.S. economy” as he perpetuated the moral hazard: if you win you’re on your own, but if you lose you can count on our support. Yellen, and now Powell, maintained this approach. All three of Powell’s predecessors claimed that the asset prices they helped inflate in turn aided the economy through the wealth effect. Which effect we all admit is real. But all three avoided claiming credit for the ensuing market breaks that inevitably followed: the equity bust of 2000 and the housing bust of 2008, each replete with the accompanying anti-wealth effect that came when we least needed it, exaggerating the already guaranteed weakness in the economy. This game surely is the ultimate deal with the devil.
> prosecuted those who have intentionally created short squeezes.
Invariably, those who cause short squeezes are the people who get themselves into tenuous shorts that they cannot finance. I have heard of situations where the SEC went after "short and distort" schemes. I have never heard that investors got in trouble for buying stock because they reasonably believed it would go up and candidly shared their trade thesis with other market participants. The market wouldn't even have a way to discover short positions to target, because the regulators don't require them to be disclosed.
Of course short squeezes (like any asset mispricing) can be good for individual market participants: but on net for all participants, they are not. That's why regulators step in when assets are mispriced, and they have attempted to/successfully prosecuted those who have intentionally created short squeezes.