Sun, Sep 21, 2008 page11

• Ban on short-selling could distort market

  TARGETED? On Wall Street, professional short-sellers said they were unfairly picked out by the government, and analysts said the ban could distort already edgy markets

  • AP
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  The US government’s unprecedented move on Friday to ban people from betting against financial stocks might be a salve for the market’s turmoil but could also carry serious unintended consequences.

  In a bid to shore up investor confidence in the face of the spiraling market crisis, the Securities and Exchange Commission temporarily banned all short-selling in the shares of 799 financial companies. Short selling is a time-honored method for profiting when a stock drops.

  The ban took effect immediately on Friday and extends through Oct. 2. The SEC said it might extend the ban — so that it would last for as many as 30 calendar days in total — if it deems that necessary.

  The short-selling ban is “kind of a time-out,” said John Coffee, a professor of securities law at Columbia University. “In a time of crisis, the dangers of doing too little are far greater than the dangers of doing too much.”

  But on Wall Street, professional short-sellers said they were being unfairly targeted by the SEC’s prohibition. And some analysts warned of possible negative consequences, maintaining that banning short-selling could actually distort — not stabilize — edgy markets.

  Indeed, hours after the new ban was announced, some of its details appeared to be a work in progress. The SEC said its staff was recommending exemptions from the ban for trades market professionals to hedge their investments in stock options or futures.

  “I don’t think it’s going to accomplish what they’re after,” said Jeff Tjornehoj, senior analyst at fund research firm Lipper Inc.

  Without short sellers, he said, investors would have a harder time gauging the true value of a stock.

  “Most people want to be in a stock for the long run and want to see prices go up. Short sellers are useful for throwing water in their face and saying, ‘Oh yeah? Think about this,’” Tjornehoj said.

  As a result, restricting the practice could inflate the value of some stocks, opening the door for a big downward correction later.

  “Without offering a flip-side to the price-discovery mechanism, I think there’s a pressure built up in stock prices that only gets relieved in a great cataclysm,” he said.

  Short selling involves borrowing a company’s shares, selling them, and then buying them to return them to the lender later, when the stock falls. The short-seller pockets the difference in price.

  Although the practice can make markets more efficient and bring in more capital, the government argues that it has widened the scope of the recent financial crisis and contributed to the collapsing values of investment and commercial bank stocks in particular.

  Government officials on both sides of the Atlantic have been denouncing hedge funds and other short sellers they say have swarmed over the limp bodies of venerable investment banks and other big companies. New York Attorney General Andrew Cuomo likened them to “looters after a hurricane,” and his office is investigating a possible conspiracy among short-sellers to spread negative rumors to pound companies’ stock prices down.

  The turmoil in recent weeks has swallowed some of the most storied names on Wall Street. Three of its five major investment banks — Bear Stearns, Lehman Brothers and Merrill Lynch — have either gone out of business or been driven into the arms of another bank. Many contend that short-selling played a key role in forcing the collapse of these institutions.

  Over the summer, the SEC imposed a 30-day emergency ban on “naked” short selling — where sellers don’t actually borrow the shares they sell — in the stocks of mortgage finance giants Fannie Mae and Freddie Mac and 17 large investment banks. But Friday’s ban expanded to all short selling, not just the more aggressive naked variety, and to a much wider universe of companies.

  However, investors still have ways to place bearish bets: by trading in options that turn profitable when a stock drops.

  Jim Chanos, a prominent short seller and president of a US$7 billion hedge fund, Kynikos Associates, called short-selling a “vital investment strategy” and said banning the practice “will not enhance long-term market integrity.”

  He said that investment banks’ bad bets on risky assets — not predatory short-sellers — were the true cause of the steep declines in the stock price of financial firms.

  “Far from being the cause of the crisis, many short sellers were warning months and years ago about problems in this area,” Chanos said in a statement.
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