Sep 15 2010 (Reuters) -- EU unveils clampdown on financial speculators
The European Union's executive unveiled a blueprint on Wednesday to curb or ban short-selling and tighten controls on derivatives in one of its most ambitious financial reforms since the economic crisis unfolded.
Europe's financial regulators mean well: "No financial market can afford to remain a Wild West territory. We have to limit risks of hyper-speculation." To that end, the new pan-European regulatory agency will have "unprecedented powers to impose 3-month bans on short-selling," "demand that short trades be flagged to regulators," while "large short positions -- over 0.5% of a company's market value -- would be made public."
If you're wondering whether this will save European stock markets from another meltdown, think back to the summer of 2008. On July 21 of that year, the U.S. Securities and Exchange Commission made it illegal for U.S. speculators to sell short shares of stock that they had yet to borrow ("naked short selling"). The move was billed as an "emergency order by Wall Street regulators to combat ‘bear raids.’" One money manager told USA Today that "The SEC crackdown essentially took much of the gunpowder away from the bears."
Do you remember where the DJIA went shortly after? On August 1, 2008, the Dow stood at 11,326. By October 10, it was below 8,500.
Why didn't the U.S. ban on short selling help stop the crash? EWI President Robert Prechter explained why in his August 2008 Elliott Wave Theorist:
"Short sellers, 'naked' or covered, still need to buy back the stock they are short, so naked short selling does not force stock prices down any more than it will force them up later. Bullish buyers can always make naked short sellers cover if they have the inclination and the money. It’s just that, in a bear market, they don’t."
EWI's Chief Analyst Steven Hochberg added in September 2008: "...the ban on short selling won’t help liquidity; it will hurt it. This unintended bearish consequence was covered [in Prechter's] Conquer the Crash." Here's what Steven referred to:
"In a bear market, bullish investors always come to believe that short sellers are 'driving the market down,' when in fact, the decline is almost entirely due to selling from within their own over-invested ranks. Sometimes authorities outlaw short selling. In doing so, they remove the one class of investors that must buy. Every short sale (except when stocks go to zero) must be covered, i.e., the stock or derivative contract must be purchased to close the trade. A ban on short selling creates a market with no latent buying power at all, making it even less liquid than it was. Then it can dribble down day after day, unhindered by the buying of nervous shorts. Like all other bans on free exchange, a ban on short selling hurts those whom it is designed to help."
-- Bob Prechter, Chapter 20, Conquer the Crash