U.S. joins worldwide crackdown on short sellers

By Rachelle Younglai and Jack Reerink

WASHINGTON/NEW YORK (Reuters) - Regulators around the world curbed short-selling of financial shares on Friday, igniting a huge rally in a sector that had been targeted by sellers as the credit crisis deepened.

Having been slammed for perceived inaction, U.S. Securities and Exchange Commission Chairman Christopher Cox announced a list of 799 financial stocks on which short-selling was banned until October 2.

The ban on short sellers -- investors who sell borrowed stock in the expectation its price will fall, and then buy it back more cheaply -- was part of a worldwide crackdown kicked off by the UK regulator late Thursday.

"It's absolutely the right thing to do. These are extraordinary times, extraordinary markets, and they require exceptional measures," said Keith Skeoch, chief executive of Standard Life Investments.

The measures caused financial shares around the world to jump as much as 40 percent, but also triggered a flood of criticism from financial market pros.

The main complaint was that the crackdown was a knee-jerk reaction that will not fix the banking sector's underlying weaknesses -- a pile of bad debts, hard-to-value mortgage securities and a breakdown of investor confidence.

"Going after the short sellers is little more than a witch hunt," said John Standerfer, vice president of financial services at S3 Matching Technologies. "The real issue is that some financial institutions have negative balance sheets."

Former Fed Chairman Alan Greenspan simply called it a "terrible idea."

MAGIC RECIPE

The ban hits the most common trading strategies used by the $1.9 trillion hedge fund industry: outright short sales and trying to profit from small price differentials between stocks and convertible bonds or stocks in the same sector.

The SEC also required fund managers with accounts of more than $100 million to report their new short sales -- a measure directed against hedge fund managers, who are notoriously secretive.

"It is like being asked to give away your magic recipe," said Philippe Bonnefoy, who invests in hedge funds at Geneva-based Cedar Partners. "The industry is alive, but badly burned."

Industry lobbyists in London and Washington protested the rule, saying they were troubled by government meddling in free markets.

"Banning short-selling of financial stocks, while it may indeed bring temporary relief, creates an artificial market," said Florence Lombard, chief executive of hedge fund lobby group the Alternative Investment Management Association.

Chicago traders, who sell stock short to balance their option positions, warned that the measure could paralyze derivatives markets and ripple through mainstream stock markets. The SEC later exempted short sales by market makers -- traders who provide bids and offers for stocks, options or other securities.