Short-Selling Ban Is a Bad Idea

09/30/2008 9:56 am EST

Focus: OPTIONS

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts, says the ban on short-selling in financial stocks won't work and may hurt.

The US Federal Reserve, the British Parliament, and the Australian government [have] outlawed some or all short-selling to protect overleveraged or fundamentally lousy financial institutions from what they said were unfair attacks on their stocks.

All I have to say to that is this: remember how well Prohibition worked out the last time the government outright banned something that subjective public officials decided was bad?

In mid-2007, the SEC ended the up tick rule, which the occasional TV pundit claims is the cause of the markets' decline. (The up tick rule required short sellers to sell only when a stock was on the way up-Editor.)

Then, after one year, lots of volatility and $100 billion in shares, shorting is as natural to many investors as going long. The really unfortunate thing is that, essentially, this new short-selling ban won't address the real problems with financials like Citigroup, Merrill Lynch, Morgan Stanley, Sovereign Bank, or Wachovia.

I've been warning my ChangeWave Shorts readers, and anyone who will listen on the Fox Business Channel, that these investment banks' balance sheets are atrocious, and that more write-downs will be forthcoming and forward earnings will suffer because they are selling off the very assets they need to regenerate profits and earnings.

Believe me when I say that some legitimate traders are being affected by this move to stop the shorting of 799 financial stocks till October 2nd.

And those legitimate traders include you and me, because even though we may not be directly shorting stocks, as options traders we enjoy the ability to buy puts as the safer, saner way to go short. And while we can still trade puts, the playing field is a lot rockier.

The government instituted the bans as a way to keep the perceived "bullies" from stealing the little guy's lunch money. But what they've done is actually removed the teachers from the school.

There are two kinds of short-sellers: the back-alley bullies sipping their whiskey and plotting the demise of good companies, and the protective kind of market-makers who keep things in check for the market to hedge some of their long-side bets.

Their actions ensure that the market place is liquid and fair for the rest of us. They make sure that you and I-by and large-don't pay exorbitant options premiums.

Too bad the "good guys" have to get punished because of greed and irresponsibility in the companies that are being protected. But will this temporary action be the cure-all that Wall Street is hoping for, or are the toxins simply going to burst forth at full force when the short-selling ban is lifted?

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