The ban on short-selling hurt investors
Posted
Oct 10 2008, 01:00 AM
by
Andrew Horowitz
Rating:
What is the difference between the U.S. and the Russian economy? Answer: In Russia, they do not pretend to be capitalists. Seriously though, it appears that we are getting closer to nationalizing many of the broken industries that still remain in the U.S. such as automobiles, airlines, financials and who knows what else. Our government has become heavy handed in what are supposed to be "free markets."
Considering the equity markets are in a period of historic volatility and selling pressure, many investors are wondering what exactly was the point of the SEC ban on short-selling almost 1,000 stocks?
While the ban was in force, market volatility as measured by the VIX, advanced to a record 57.53. Part of this was due to the simple fact that trading volume within the markets was artificially removed. In other words, the usual selling and buying that was done by hedge funds and other short-sellers was non-existent.
It can be loosely compared to the after-hours markets where we often see exaggerated trading volatility. This is because there are fewer traders chasing the available shares. Therefore, spreads are wider and investors usually see a much greater range of pricing. 
The research that has been made available has not provided any concrete proof as to whether the ban actually worked. Some reports have shown that the protected companies on the list had a median decline of 12.9% over the period as compared with a 17.8% loss for the Standard & Poor's 500 Index and a 23% decline for the Russell 2000 Index. But the "median" figure is somewhat misleading.
A better comparison is to consider the Financial Select Sector SPDR Fund or XLF, which is an exchange-traded fund tracking financial companies. This was down nearly 26% during the same period.
In addition, there is even more concern about the effectiveness of the ban overseas as Bloomberg reported:
"The short selling ban hasn't stopped the decline in bank stocks. An index of the 34 U.K. financial stocks on the banned list has fallen 22 percent since Sept. 19, compared with an 18 percent drop for the FTSE 100 Index of the largest U.K. companies and 10 percent for the FTSE All-Share Index."
It appears that this temporary ban was not well thought out before it was thrust upon investors. In fact, many stocks initially received a boost when the plan was announced, only to then find themselves moving down again as additional economic data was announced. The ban could have actually hurt investors as many were swayed to buy/cover these stocks since they believed there was some level of protection provided. Unfortunately, we now know differently.
Next time, perhaps the Fed and/or SEC will put some more thought and enlist the help of outside economist who can provide well thought out and properly researched recommendations before implementing such an important rule. Is that asking too much?
Related reading:
What happens when short ban expires?
The Disciplined Investor Podcast: Bill Fleckenstein Guest
Free Online Trading Class with Andrew
Short Selling Ban draws to end
Andrew Horowitz is a money manager and the founder of Horowitz & Company. He is also the author of the bestselling book, The Disciplined Investor . Check out his latest investment idea or listen in as he hosts, The Disciplined Investor Podcast.
