Proposals to ban short selling of regional bank stocks are a bad idea. Although banning short selling appeals to politicians who want to show that they are doing something, in reality it is the functional equivalent of blaming the messenger for delivering bad news. The main problem the financial system currently faces is the balance-sheet weakness of regional banks, and banning short selling of their stocks does nothing to address the weakness. In addition, the ban on short selling has other adverse consequences. Short selling is a way for investors to bet that the stock price is going down. Those who support such restrictions should study market history. Consider the short selling ban imposed by the SEC in September 2008, four days after the collapse of Lehman Brothers – the largest bankruptcy filing in US history. The ban applied to 799 financial stocks, and SEC Chairman Christopher Cox at the time said the ban would “restore balance to the markets.” It didn’t work that way. In December 2008, three months after the ban took effect, the Financial Select Sector SPDR ETF XLF, -0.19% ]was down 44%. (See accompanying chart.) Reflecting on the experience, Cox then said: “Knowing what we know, I believe in balancing the commission. [SEC] It won’t do [ban short selling of financial stocks] again The costs seem to outweigh the benefits.” The costs Cox was referring to are market quality, volatility (which increases following a ban on short selling), bid-ask spread (which widens), and liquidity (which decreases). Although these costs are dispersed as opposed to concentrated in one stock or sector, they add up to significant losses overall. University of Utah finance professor Matthew Ringenberg, who researches short selling, said in an interview. That academia has extensively studied the impact of the 2008 ban, and reached the same conclusion as Cox: “The academic research is clear: the 2008 short selling ban harmed market quality and was potentially counterproductive.” Ringgenberg continued: “In the current case, short sellers are not the cause of the banks’ problems. In most cases short sellers are simply reacting to negative fundamental information about bank balance sheets. Banning short selling will not fix bank balance sheets.” Short sellers are an easy target, and it’s tempting to blame them. But wrong analysis will not help you beat the market. Mark Hulbert is a regular contributor to MarketWatch. Their Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com More: Stocks are stuck in a trading range, but watch the VIX for signs of a breakout Also read: Hindenburg says Icahn renews stock as recent company announcement raises more questions about company’s debt, losses
