FINANCIAL SHORT SALE BAN SET TO EXPIRE

The SEC's ban on short sales of a market basket of financial firms is set to expire at 11:59 p.m. Wednesday evening.

You can say that, if the intent of the ban was to support the price of the targeted stocks, the effort has failed: from the close of 9/17 (the last full day of trading before the ban was imposed) through the close today, financial stocks were down nearly 40% more than the Dow.

Additionally, volatility is now at record levels; the VIX index, which basically measures levels of fear in the financial markets, is nearly twice as high as it was in the early stages of this crisis (and at the highest point since the index was created over 18 years ago):

Why would volatility have continued to rise in the face of a ban on short selling, which we might think would calm the markets? Short selling, rather than the parasitic behavior that the SEC and the CEO's of financial firms perceive it to be, is just one more tool that investors can use to hedge, or limit risk. By restricting short selling, the SEC sent a signal to investors to stay out of the market until the short sale ban is over. Since the vast majority of investors take long positions in stocks, this translated into a generalized buyer's strike. Why would this be? On one hand the ban on short selling increased the risk of taking long positions in financial companies as hedging those positions had become more difficult; and on the other hand the ban gave investors the perception that the ban would result in pent-up selling pressure that could precipitate a new leg down in financial stocks once the ban was lifted.

Since financial stocks lead the stock market as a whole (no stock market rally can be sustained in the face of a decline in financial stocks), why would any investor take ANY position in the stock market during the period of the short sale ban? During the period of the ban, the U.S. stock market lost over $6T in value, losses that would have been realized by anyone who was scared out of the market or was forced to sell by virtue of a margin call. Therefore, we can reasonably argue that Christopher Cox and the SEC helped the pension funds of the United States lose $6T by their wrong-headed decision.

So, now that the ban is set to expire, what can we expect to happen? While it is very hard to say, I believe that the end of the ban will usher in a rally in financial stocks, for the same reasons that I attribute the steep market declines to the ban. Able to hedge positions, investors will feel safer taking those positions. And, any good news could easily trigger short covering rallies, which were out of the picture when short selling was banned.

Moral of the story: don't mess with the free market.

Christian Antalics