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Naked Ban Lifted

The SEC has lifted their ban of naked short selling on Freddie Mac and Fannie Mae stocks. The ban was put in place last month after both stocks slid in price and ended Tuesday at 11:59 pm. The SEC said they have no plans to extend the ban; however, it was necessary at the time to help prevent stock manipulation and abusive ‘naked’ sales.
 
For those still new to the world of smart investing, short selling is when an investor bets that a stock’s price will fall, so they “borrow” shares of that stock and then sell them. If the price does fall, then they buy the cheaper actual shares to cover the borrowed ones and are able to pocket the difference. This practice was not banned by the SEC.
 
However, naked short selling (which sounds so much more fun than it actually is) occurs when the sellers don’t bother to borrow the shares before selling them. Instead, they buy the cheaper shares to cover the positions immediately after the sale. There’s some risk with this because there is no guarantee that the prices will fall; however, the SEC banned this practice on Freddie and Fannie stocks to prevent “distort and short” manipulation of stocks. This happens when rumors are used to drive down the price of a stock that has been sold short.
 
Analysts and government regulators are blaming aggressive short selling for bringing about the recent plunge of Freddie and Fannie stocks, as well as that of Lehman Brothers Holdings. They are in full support of reinstating the ban. Meanwhile, advocates for smaller banks and investment firms are pushing for the SEC to extend the ban on naked short selling to cover other financial companies.
 
Because the situation surrounding the ban is so unusual, there’s not really a way to measure how effective it was. Obviously, the stock prices rebounded a little, but no one can determine if that was because of the ban or not. What do you think? Did the ban help the stock prices for Freddie and Fannie? If so, would such a ban help other financial companies as well? [USA Today]
 

Posted: 8/13/08