August 10, 2012 / 4:22 PM / 5 years ago

Short-selling bans failed to prevent US stocks declines: NY Fed

NEW YORK, Aug 10 (Reuters) - Bans on short-selling imposed during the financial crisis in the belief that short sales were driving U.S. stock prices below fundamental values did little to stabilize those prices, according to a study by New York Fed economists.

U.S. regulators banned the short-selling of financial stocks during the 2008-09 crisis and have selectively applied restrictions on short sales at other times.

The study looked at the bans’ effectiveness in limiting price declines in 2008. It also looked at the effect of short-selling in August 2011, when debt-rating agency Standard & Poor’s lowered the U.S. sovereign long-term credit rating. The move prompted the S&P 500 to fall 6.66 percent on the next trading day, when there was no short-selling ban in place.

Results showed short-selling restrictions did little to slow declines in financial stocks when they were in effect in 2008. Share prices fell more than 12 percent over the 14 days in which the ban was in effect. The ban also increased trading costs in the equity and options markets by more than $1 billion.

The Fed economists also said there is no evidence that stock prices declined following the downgrade of the U.S. credit rating as a result of short-selling.

“A statistical exercise conducted to determine the relationship between short-selling and stock returns finds that the two variables are minimally correlated,” the study said.

Short-selling entails borrowing shares and then selling them in the expectation they can be repurchased later at a lower price. Although the practice is common, there are concerns that short-selling drives stock prices to artificially low levels.

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