In Defense Of Short-Sellers: Bans Cost Investors More Than $1B In 2008

There’s been a lot of talk about short-selling bans and their effectiveness over the last couple of years. From Jim Chanos with Enron and David Einhorn with Lehman Brothers then and Green Mountain Coffee now, there have been many cases of short-sellers effectively targeting companies that markets eventually condemned. Yet regulators have insisted with short-selling bans in order to stanch the bleeding when market turmoil turns up the heat on beleaguered financial stocks, most recently in Spain and Italy.

In the latest of the debate, an economist for the New York Fed teamed up finance professors from Notre Dame University and published a research paper in which they note that not only are short-selling bans ineffective (i.e. the stocks targeted by the ban actually performed worst than others), but it also raises liquidity costs to the point where in 2008, it cost equity and options trades more than $1 billion. Furthermore, short-sellers do have a positive effect on markets, by targeting overpriced companies, but at times, they may have too much power.

Authors Hamid Mehran, Robert Battalio, and Paul Schultz looked at the effects of the short-selling ban instituted on September 19 in the wake of the Lehman Brothers bankruptcy in a paper titled Market Declines: What Is Accomplished by Banning Short-Selling. They then compared that to the performance of stocks in the aftermath of the 2011 credit downgrade of the U.S. at the hands of Standard & Poor’s, when the S&P 500 fell 6.6%, marking its worst decline since the depths of the financial crisis.

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