A trader reacts as he looks at computer screens at the Madrid Bourse July 24, 2012. Spain and Italy both introduced short-selling bans on Monday, reacting to steep falls in their stock markets and as confidence slipped in their ability to repay their debts, prop up their banking systems and tend to their economies while remaining within the euro currency.ANDREA COMAS/Reuters
It's possible that you've long doubted the effectiveness of short-sale bans on saving stock markets from steep declines. It's a discussion topic that became popular again after Italy and Spain's regulators instated a temporary ban on shorting just a few weeks ago.
And now there are numbers to back up the theory. In a study released Friday by the Federal Reserve Bank of New York called "Market Declines: What is accomplished by banning short-selling?" the authors have found a way to quantify the market impact of these bans.
The U.S., of course, has also banned short-selling before. The U.S. Securities and Exchange Commission did so around the time the recession hit in 2008 (from September 18 to October 8, to be exact). Its intention was to try to stuff a towel under the door of melting stock prices – the SEC thought the short-sellers would drive down stock prices to unnaturally low levels. Instead, liquidity costs went up. And up, and up. "Together, the inflated costs of liquidity attributable to the short-sale ban in U.S. equity and options markets are estimated to exceed $1-billion," the report notes.
That's right: The research suggests that not only did the bans not stem the decline of financial stock prices (which dropped by more than 12 per cent during the shorting blackout), but they actually plugged up liquidity while trading costs rose. The stocks that the researchers charted didn't steady themselves until after the ban was lifted.
Lest we think that the bans at least prevented the stock from falling further, the researchers go on to say that excess returns amassed by stocks in countries where there were no short-sale bans looked very similar to those where such trades were forbidden (so long as there weren't also policy changes at the same time, which could alter the numbers). This information led the study to conclude that the bans set near the beginning of the recession in 2008 and 2009 were "at best neutral in its effects on stock prices."
The report may not cause any big upset in the world of financial regulation, but it is yet another message of caution towards blindly attributing price declines in the market to short-sellers.