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Short-Sell Traders Say Ban Is Bad For Market

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By MARCY GORDON and STEVENSON JACOBS

The Associated Press

Published: September 20, 2008

WASHINGTON - The government's unprecedented move Friday to ban people from betting against financial stocks might be a salve for the market's turmoil, but it could 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 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 Friday and extends through Oct. 2. The SEC said it might extend the ban - so that it would last for 30 calendar days - if it deems that necessary.

Experts say the SEC is presuming that window would be enough time to calm the roiling financial markets, with the Bush administration's massive new programs to buy up Wall Street's toxic debt possibly starting to have a salutary effect by then.

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."

On Wall Street, professional short sellers said they were being unfairly targeted by the SEC's prohibition. Some analysts warned of possible negative consequences, maintaining that banning short selling could distort, not stabilize, edgy markets.

"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 will 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.

They Buy It Back, Keep The Difference

Investors "sell short" if they think the shares of a particular company are going to decline and they want to profit from the drop.

To do this, an investor borrows shares of Company X, usually from a broker, and then immediately sells the shares at their market price, say $100 a share.

If the share price falls, let's say to $80, the investor buys back the shares and returns them to the broker. The investor pockets the difference, in this case, $20 a share.

The practice can be risky: If the shares increase in value, the investor has to buy them back at a higher price and loses money.

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 down companies' stock prices.

Some Say Practice Collapsed Banks

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.

SEC Chairman Christopher Cox, who with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke had met with lawmakers at the Capitol on Thursday night, acknowledged that such extraordinary measures would not be necessary in a well-functioning market and said they are only temporary.

Cox said Friday his agency "is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets." He said the temporary ban "will restore equilibrium to markets."

The SEC also imposed a new requirement, also temporary, for investment managers to publicly report their new short sales of stocks. The agency also eased restrictions on the ability of companies to buy back their own shares, also through Oct. 2, another move aimed at helping restore liquidity to the distressed and volatile market.

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.

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