THE STASH NOVEMBER 16, 2009
Regulators around the world, including our own SEC, succumbed to populist fervor following the Lehman collapse and banned short-selling "to protect the integrity and quality of the securities market and strengthen investor confidence."
It's still an open question as to whether the ban had any positive effect on investor confidence, but evidence is piling up that "quality" -- a market's ability to provide liquidity and price discovery -- headed south. The latest analysis comes from two European economists, Alessandro Beber and Marco Pagano, who looked at the effects of short-selling bans on over 5,000 stocks in 19 countries after Lehman's collapse. They found that:
the knee-jerk reaction of most stock exchange regulators around the globe to the financial crisis – imposing bans or regulatory constraints on short-selling – has been detrimental for market liquidity and price discovery, and at best neutral in its effects on stock prices. The ban-induced decrease of market liquidity is especially serious because it came at a time when bid-ask spreads were already high as a result of the crisis and investors were desperately seeking liquid security markets due to the freeze of many fixed income markets.
Interestingly, the United States was the only 'ban country' that saw the price of banned stocks increase. On average, protected stocks actually underperformed the local stock market index. What explains the U.S.'s uniqueness here? Beber and Pagano suggest that the extensive federal and central bank support in the U.S. may have played a role.
But the news isn't all bad. Quoting former SEC chairman Chris Cox, Beber and Pagano do point out one benefit from short-selling bans:
Perhaps the main social payoff of this worldwide policy experiment has been that of generating a large amount of evidence about the effects of short-selling bans. The conclusion that this paper distils from this evidence is best summarized by the words of [Chris Cox]: “Knowing what we know now, ... [we] would not do it again. The costs appear to outweigh the benefits."