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.”
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.
Wall Street chiefs and U.S. lawmakers had pressured Cox to limit short-selling after plunging share prices and a loss of investor confidence pushed Lehman Brothers into bankruptcy court and Merrill Lynch & Co Inc into the arms of Bank of America Corp. last weekend.
The clamor for action increased after the two remaining big U.S. investment banks, Goldman Sachs Group Inc and Morgan Stanley, saw their share prices plummet this week. Morgan Stanley Chief Executive John Mack blamed “the shorts” after Lehman’s chief Dick Fuld had been railing against them for months.
As markets plunged and financial shares appeared in free-fall on Thursday, U.S. presidential candidate John McCain said Cox should be fired for failing to prevent the Wall Street melt-down.
Cox later that day gathered with U.S. Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and Congressional leaders at a Capitol building emergency meeting that ended at 8:30 p.m.
By that time, the UK Financial Services Authority had already imposed a four-month ban on short-selling of financial stocks. National market watchdogs in Australia, Portugal and Ireland followed overnight with similar measures, and Cox announced his own set of rules on Friday morning.
Cox’s list is likely to be revised, an industry source said, as some major financial companies like American Express Co and CIT Group Inc were accidentally left off. Some called the list arbitrary altogether.
“The government is doing everything possible to protect financial stocks and prop them up in the short term and try to get through a weekend without someone blowing up,” said Matt McCormick, portfolio manager at Bahl & Gaynor Investment Counsel in Cincinnati, Ohio. “These new short-selling rules open a Pandora’s box. What happens to the auto sector? The airline sector?”
Reporting by Rachelle Younglai, Karey Wutkowski and Jeremy Pelofsky in Washington, Svea Herbst-Bayliss in Boston, Paul Hoskins, Steve Slater, Cecilia Valente, Joel Dimmock, Laurence Fletcher, Lorraine Turner and Myles Neligan in London; writing by Jack Reerink; Editing by Gary Hill