The German Securities Exchange Commission, the Bafin, announced on Monday that it temporarily prohibits naked shorting and uncovered CDS in government bonds of euro zone countries to counter excess volatility. It also prohibits uncovered short-selling transactions in the shares of a number of companies from the financial sector (read the full press release here).
The latter measure is remarkable in light of a recent empirical study of short selling bans in response to the financial crisis by Alessandro Beber and Marco Pagano, which finds that find that bans (i) were detrimental for liquidity, especially for stocks with small market capitalization, high volatility and no listed options; (ii) slowed down price discovery, especially in bear market phases, and (iii) failed to support stock prices, except possibly for U.S. financial stocks (the study is available here).
Indeed, a strategist of Deutsche Bank (which, incidentally, is one of the companies whose shares are subject to the ban) was quoted as saying that "What we've learnt repeatedly in this crisis [is] that every action has an equal and opposite reaction ... If the authorities prevent free market activities in some areas, the risk is that the pressure moves somewhere else."
Combine the law of unintended consequences with the profit motive and you get regulatory arbitrage. Personally, I'd rather trust markets than governments and the german action is one more data point in favor of that view.
