U.S. regulators restored investors' rights to make bearish bets on financial stocks but few expect it to put an end to wild swings in the market.
For nearly three weeks, investors who bet on falling stock prices were prohibited from short selling more than 950 companies under an experiment by securities regulators to restore equilibrium to a fragile financial system.
Short sellers arrange to borrow shares they consider overvalued and sell them. If the price drops, they repurchase shares, return them and pocket the difference.
It's questionable whether the U.S. Securities and Exchange Commission's temporary ban worked. S3 Matching Technologies, a market data firm, said it found no statistically significant differences between stocks covered under the ban and those that were not.
The S&P financial stocks sub-index dropped 23.6 percent over the length of the ban, hitting its lowest level in more than a decade on Tuesday. Financial stalwarts like Bank of America saw its stock lose 27.7 percent and Citigroup fell 14 percent amid fears of a global financial meltdown. The stock of Morgan Stanley, whose chief executive John Mack lobbied for short-selling relief from regulators, lost 25.5 percent over the three-week period.
Although the ban was lifted, the SEC plans to craft a permanent disclosure rule requiring big short-sellers to report their trades to the agency. It remains unclear if the data will be kept secret by regulators or eventually made public.
On September 19, the SEC imposed an emergency ban on short selling of nearly 800 financial services sector stocks. After other firms clamored to be included, the list eventually grew to more than 950 stocks with some additions that raised eyebrows such as drug store chain CVS Caremark Corp.
But rather than stabilizing prices, U.S. stocks continued to swing wildly on fears Congress would fail to pass a $700 billion bailout law to help choked credit markets. Since the bill was signed into law last Friday, stocks have tumbled lower.
Robert Francello, head of equity trading for APEX Capital hedge fund in San Francisco noted that some funds refrained from buying shares during the ban as they were not able to short to hedge their positions.
"I think the lifting of the ban will have a net positive impact. You are bringing back huge amount of liquidity and there are going to be more active participants and you will get prices that are more stable."
SHORTS SAY THEY WEREN'T TO BLAME
Hedge funds, which often employ short selling strategies, vehemently opposed the SEC's emergency ban. Well-known short sellers James Chanos and William Ackman said the sell-off in financial stocks proved that short selling is not to blame for the current crisis.
It is a legitimate investment strategy which helps keep markets liquid and stocks from becoming overvalued, analyst argued.
However, in the days leading up to the SEC's drastic action, Lehman Brothers collapsed, U.S. authorities were forced to rescue insurance giant American International Group, shares of major financial firms were pummeled and fear that more firms would collapse was rampant.
The U.K.'s Financial Services Authority imposed a four-month ban on short selling in financial firms. Regulators from Canada, Australia and Germany followed suit.
