Did the Ban on Short-Selling Make a Difference?

At the stroke of midnight on Wednesday, the short-sellers will return to Wall Street.

The question is, what will they do when they get there?

Nearly three weeks ago, regulators abruptly banned short sales of financial stocks to protect companies that had come under siege in the stock market. Short-sellers, critics said, had contributed to the declines by betting against the companies’ shares.

But once the ban expires Wednesday night, shorters—viewed as villains by some and heroes to others—will be free to ply their trade again.

Few expect their return, on its own, to spark another precipitous plunge in the stock market.

Financial shares have plunged 23 percent since the ban was imposed on Sept. 22, suggesting that the short-sellers might not have played such a big role in the declines.

The Securities and Exchange Commission took additional steps, which will remain in place, to hem in short-sellers, who typically borrow shares and sell them, hoping to buy them back later at lower prices and pocket the difference. The S.E.C. has shortened the length of time allowed to locate borrowed shares for short-sellers and will require investors to begin disclosing the stocks they short. That may discourage some investors from the practice.

Since the S.E.C. ban went into effect, borrowing shares has become more expensive, in part because some big pension funds and endowments have stopping lending stock altogether.

Whether the ban worked, given the market plunges that followed, is a matter of debate.

“If there had been no ban, would they have gone down even more?” said Mozaffar Khan, a professor who as studied short-selling at the Sloan School of Management at the Massachusetts Institute of Technology. “Normally the studies that we do are in normal times, and we just don’t know in a state of panic what the outcome would have been.”

The controversial ban clearly had some unintended consequences. It originally applied to 799 companies, but regulators allowed the stock exchanges to add other companies to the lists. By this week, about 190 had been added, including some that might not seem obviously linked to the banking industry, like General Electric (GE is the parent company of CNBC), General Motors and CVS Caremark . The list became a source of jokes among traders, who came up with all kinds of conspiracy theories—such as companies rushing out negative earnings revisions as soon as they angled their way onto the list.

Hedge funds, which are down nearly 10 percent for the year, blame the rules for pushing them deep into the red. Many trading strategies rely on short-selling, and investors may have sold off some of their long positions in the market, driving prices down, because they were not able to hedge their bets with a corresponding short position. Convertible bonds—which are used to raise money for many banks this year—were especially battered because traders typically short a company’s stock when they invest in its preferred shares, for instance.

“It’s the kind of thing I would expect would happen in an emerging market,” said William Ackman, chief executive of Pershing Square, a hedge fund firm in New York, of the ban. “You have to think through the consequences of your decisions. It was a very big negative for the market in general.”

Nasdaq studied the changes in the market during the week before and the week after the short ban and found that the percent of selling in the market that was short-selling dropped to 16 percent, from 44 percent, for financial companies. Even nonfinancial company stocks saw less shorting. And transaction costs increased. The spread between the prices that buyers and sellers of stocks were willing to use for trades increased by 42 percent for financial stocks.

“The ban was a blunt instrument,” said Robert Greifeld, chief executive of Nasdaq OMX.

The raw number of trades in financial stocks also dropped, as many investors simply sat on the sidelines. Trading volume of Wells Fargo , for instance, fell 45 percent and trading in Bank of America fell 53 percent.

“There’s liquidity out of the marketplace,” said H. Seth Berlin, the principal at Performance Thinking & Technologies, a hedge fund consulting firm. “Did the ban really do what it was supposed to do? Probably not.”

Some investors said that bringing short-selling back to the market could actually bolster stocks. Andrew Fishman, president of Schonfeld Group, an asset manager in New York, said that some of his clients wanted to exit short positions in recent weeks, which would have meant purchasing shares, but they did not do so because they feared they would not be able to borrow the stock again to short it later on.

Mr. Fishman said short-selling has been wrongly blamed. The real problem, he said, is the weakness of financial institutions.

“You can never change the path of a stock,” Mr. Fishman said. “If it’s going to go down, it’s going to go down.”