If You Ban Shorting, You Ban Information

Posted by Bull Bear Trader | 10/20/2008 02:04:00 PM | , | 0 comments »

There is an interesting article today in the WSJ regarding the recent short selling ban, along with its unintended consequences. While the effects on hedging, volatility, and widening bid-ask spreads have been discussed at length, what often gets lost in the discussion is the effect on market efficiency (see previous post). As quoted in the recent article:

"Why would regulators ban short selling in nearly 1,000 companies, effectively banning accurate information from the markets? By targeting short sellers as a way to prop up share prices, regulators clearly panicked. This in turn panicked financial professionals and individual investors who saw regulators losing faith in the system they oversee."
In a sense, by trying to stabilize stocks, current actions have made them more volatile. Even worse than affecting individual stocks, such bans have destabilized the confidence and structure of the market itself, and made information flow less transparent. Individual stocks can recover, or can be sacrificed, but confidence must be built. Market structure must be consistent and trusted. Hopefully we have learned our lesson over the last few weeks as we continue to watch greater than 5% daily swings, not to mention material market moves (often down) every time someone from Washington shows up at a press conference.