Short Selling Bans Found to Be Ineffective and Raises Liquidity Costs

“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 Coffeenow, 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.”

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