Short-selling bans don't work – Cass study

Short-sellers have become one of the new public swear-words that have emerged from the financial crisis. Their defenders are often dismissed as more of the same bankers who brought us the crisis in the first place. Why should short-selling be allowed? Isn't there something deeply wrong, at some level, somehow, about wishing share prices to fall. Isn't that like hoping for failure, or seeking to steal?

Most regulators around the world reacted to the 2007-09 crisis by imposing bans or constraints on short-selling. Even in the United States, where the pressure of lobbying from Wall Street was intense, the Securities and Exchange Commission issued curbs on short-selling in the wake of the Lehman Brothers failure in 2008. Briefly. One of the worst decisions of his time in office, said SEC chairman Christopher Cox at the time. Bans and partial bans were imposed and lifted at various times by various countries. Some are still in place. Some were more restrictive than others, giving the basis for a natural experiment of the sort economists love to find. A pair of scholars from London's Cass Business School and the University of Naples looked at the resulting data and concluded:

• Liquidity: Bans were detrimental for liquidity, especially for stocks with small level of market capitalisation and no listed options. Trading just dried up when the market-making element of stock lending and short-selling disappeared.
• Prices: Bans led to slower price discovery, especially in bear markets. Prices simply didn't adjust very quickly to new developments, as would-be sellers had trouble finding buyers, presumably because they feared not being able to get rid of a position later on.
• Price support: Bans didn't do what they were meant to do. They failed to support prices, with the possible exception of US financial stocks, where the bans were lifted after only a short period.

The scholars conclude: "in contrast to the regulators' hopes, the overall evidence indicates that short-selling bans have at best left stock prices unaffected, and at worst may have contributed to their decline."

Source document: The working paper "Short-Selling Bans around the World: Evidence from the 2007-09 Crisis," by Alessandro Beber of Cass Business School Marco Pagano of the University of Naples, is a 64-page pdf file.