On July 21, the Securities and Exchange Commission issued an emergency order to ban so-called naked short-selling on 19 financial stocks in order to prevent rumors from disrupting the “normal price discovery process.”

debateLast night, the order lapsed as scheduled. Now comes the job of answering the critical question: did the SEC ban work? If successful, the SEC could claim victory, perhaps extend the naked short-selling ban while opening the door to further government intervention. Failure would give financial firms fodder for arguing that financial regulators should get off their lawn. Deal Journal is interested because the battered stock prices of financial stocks that gave rise to the ban also had driven furious M&A speculation this year. If Washington is influencing these stock prices, it also is influencing the natural course of mergers.

Unfortunately, this is one messy autopsy. First, how to define success? The SEC standard was about protecting the “normal price discovery process,” but really it seemed more motivated by preventing the prices of the 19 stocks from falling further. To the latter criterion, the data show that the financial firms’ stock prices were resilient. Bloomberg today reported that the 19 covered stocks as a group rose 26% since the July 15 announcement, adding $270 billion of market cap. The 19 now are trading roughly where they were on Monday, March 17, the day Bear Stearns was sold.
Floyd Norris, in his Marketplace column, noted that the 12 pure U.S. stocks rose 23% after July 15; the S&P 500’s financials rose 22% in the same period.

Still, S3 Matching Technologies, an Austin, Texas, data firm, points out that Fannie Mae’s stock fell 40% and Freddie Mac 41%. Those two stocks, you will remember, provided much of the catalyst for the emergency order.

But academic and corporate research indicate the experiment failed. Perhaps the strongest antiban argument comes from Arturo Bris, a professor at Swiss business school IMD who is affiliated with the Yale International Center for Finance. He tracked the 19 stocks protected by the SEC’s Emergency Order and examined short-selling data provided by the NYSE.

Bris says–you can read Bris’s report here–the SEC probably didn’t even need to get involved because, from Jan. 1 to July 15, 2008, short-selling accounted for 12% of trading in the 19 stocks, compared with 13% for other, similar U.S. financial institutions. He concludes that the SEC order meddled with market efficiency, that the risk-adjusted return on the 19 protected stocks actually fell for investors, and that the rest of the financial sector–a sample size of 73 financial institutions traded on U.S. exchanges–performed a lot better in the market than the protected 19. Bris also argued that the increased short-selling in some of the 19 financial stocks could be explained by the fact that some of those firms were more active issuers of convertible bonds.

Bris’s most damning finding was that the emergency order impeded market efficiency–in effect, it distorted the “price discovery” process that it was hoping to fix. “The G19 stocks have suffered a significant reduction in intra-day return volatility and an increase in spreads, which suggests a deterioration of market quality,” Bris wrote.

In addition, some unprotected financial stocks–including Washington Mutual–were hit really hard. Bris told Deal Journal of the ban: “I think it targeted the wrong stocks.”

The data, of course, show only that short-selling didn’t hurt the firms; no one can track naked short-selling, the kind of risky bets that aren’t disclosed by investors and the target of the SEC’s ire. There are good points on either side of the debate, which is inconclusive, but we do know this: the talk of bailing out Fannie and Freddie has died down. That’s a nice reminder than an emergency order is still a heck of a lot cheaper than a government bailout.