Analysis: Effects Of Banning Short Selling

If the SEC temporarily bans short selling, it will actually INCREASE the cost to banks of raising new capital, and the market's floor might be removed.

- "The Securities and Exchange Commission took its most aggressive assault against bearish stock bets by stating its intention to issue a temporary ban on short-selling," writes the WSJ. "SEC Chairman Christopher Cox briefed Congress late Thursday of the agency's intention to take the extraordinary step of interfering with the market's regular functioning."

- This move will affect hedge funds that use short positions to hedge investment risk during a rights issue or placing. If they're not able to provide liquidity during a rights issue, the costs to banks of raising new capital will increase. 

- Shorts provide a floor, buying (i.e. covering shorts) when there is no one left to buy. If you can't short, the only way to reduce your risk is to sell, which may exaggerate downside pressure in the event of a market sell-off. A simple illustration: Look at China's stock market, where no short selling is allowed. The Shanghai composite went from 6100+ to 1800 in the space of a few months...