British financial stocks dropped 41 percent in the four months after regulators imposed a ban on short selling following the collapse of Lehman Brothers Holdings Inc. in September 2008. The benchmark FTSE 100 index fell 15 percent in the period. When the Securities and Exchange Commission prohibited short-sales for three weeks in September 2008 a Bloomberg Index tracking the 880 U.S. stocks affected fell 26 percent, outpacing the Standard & Poor’s 500 Index’s 22 percent decline.
European regulators are divided over how to respond after a rout that sent the region’s bank stocks to their lowest in almost 2 1/2 years this week. Germany and the Netherlands have said they don’t plan further restrictions on short sales, while British regulators said they don’t plan to limit the practice.
“In contrast to the regulators’ hopes, the overall evidence indicates that short-selling bans at best left stock prices unaffected and at worst may have contributed to their decline,” said Alessandro Beber, a professor at Cass Business School in London who’s studied short-sales bans in 30 countries.
Via Daniel J Mitchell, who comments:
Beber’s research (cited in the excerpt above) has been confirmed by other scholars. Simply stated, if investors realize that something is over-valued, it is going to fall in price. Governments can hinder and delay that process, thus increasing volatility and uncertainty, but they can’t stop it.
But here’s a very big reason why these laws are stupid (at least from my amateur perspective*). Most rational people presumably would agree that the housing and financial bubbles of the last decade were a bad thing. But most of us know it was a bad thing because we have 20-20 hindsight.
But what if there were lots of people back in 2005, 2006, and 2007 who recognized a bad thing as it was happening? And what if they had the ability to deflate the bubble (or at least slow its increase) by making investments that assumed housing and finance were heading for a fall?
We could have saved ourselves a lot of economic misery if that was the case. Heck, short sellers probably did save us from a lot of additional economic agony by stopping the bubbles from getting even bigger.
In other words, short sellers are the good guys.