Could the share shorting ban be causing volatility?
Is the ban on short-selling shares working? No-one can say, so let’s set up an experiment that allows hedge funds to deal in half the stocks while the rest remain protected.
The ban on shorting financial stocks was imposed by the British Financial Services Authority in September as one of its desperate ways to stop bank shares plunging. Other world regulators followed with similar bars.
Yet volatility is more extreme now than it was before the ban. Movements in whole stockmarkets – from New York via Europe to Tokyo – regularly exceed 5 per cent in a single day, sometimes double figures. Bank shares are frequently moving more than 20 per cent in a single day.
Before the shorting ban, bank stocks were in freefall. Now they move violently both ways. The plunge has been replaced by volatility.
Short-selling is when an investor sells shares he does not own but which he thinks are falling in price, with the intention of buying them at the lower price in future.
Hedge funds are the main short sellers (or any fund that sells short is likely to be branded a hedge fund) and the complaint is that they cause the share price fall rather than anticipate it.
In fact any short-sellers of banks seem to have read the market correctly over the past year, and in further fact, it turned out that it was not short-sellers leading the sales but long-only funds that were wisely dumping stock.
Yet there is an argument that short-sellers can calm markets, reducing volatility and that excluding them from the market now is what has caused shares to wobble so much.
In the absence of conclusive evidence, the jury is still out on that theory, however. The FSA (which had earlier also banned shorting bank shares during rights issues) has now reviewed its prohibition and made no substantial changes, barring shorting of the 32 named financial stocks until January 2009, when the “protection” will be reviewed again.
The FSA should invite those companies to decide whether they want the ban to continue and run a controlled experiment with shorting allowed on some stocks and barred on the others. We could then monitor which group had the more stable share prices and which were volatile.
We would then have the information to know whether such bans are useful or if they do more harm than good. It would be better than making policies based on guesses.
