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SEC Short-Selling Ban on Fannie Mae and Freddie Mac Stock Expires

The SEC order on short selling stock for Fannie Mae and Freddie Mac expired August 12th 2008. The order temporarily prohibited a specific kind of short-selling of the stocks for the home financing companies Fannie Mae and Freddie Mac and seventeen other mortgage investment banks. The companies' shares have stabilized since the ban took effect July 21. The Securities and Exchange Commission says its order helped prevent stock manipulation, and that regulators will be able to analyze data to gauge its effectiveness. But some financing experts argue that may be difficult to determine. The SEC instituted the emergency ban last month after a precipitous slide in the shares of Fannie and Freddie, the government-sponsored companies that collectively hold more than $5 trillion in home mortgage loans. Since this covers almost 50% of the home mortgages serviced in the United States, the affects of one or several of these companies going under would completely devastate the economy and could trigger the first U.S. depression since the 1930ís. On July 29, the SEC extended the ban until 11:59 p.m. EDT Tuesday, August 12, 2008 stating it would not be extended further.

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Going forward, though, the Security Exchange Commission plans to consider new rules to provide additional protections against abusive "naked" short-selling in the broader market of public home financing companies, while allowing legitimate short-selling. That prospect has aroused concern with advocates for hedge funds and private investment corporations, which continue to protest this SEC order.

An expansion of the order into a market restriction "would force firms to spend money to automate their systems and would add costs to both brokers and customers in the form of increased borrowers' fees," said Distell, a former Bear Stearns attorney. "In this time of economic uncertainty, that would not be a popular outcome for Wall Street."

Short sellers bet that a stock's price will fall so that they can profit from it. They borrow shares of the stock and sell them. If the price drops, they buy cheaper actual shares to cover the borrowed ones, pocketing the difference. "Naked" short selling occurs when sellers don't even borrow the shares before selling them, and then look to cover positions immediately after the sale.

The SEC's temporary order required short sellers to actually borrow shares before selling them. SEC Chairman Christopher Cox has said the order helped prevent potential "distort and short" manipulation of stocks, which occurs when rumors and misinformation are used to drive down the price of a stock that has been sold short. The SEC "will continue exploring other remedies for the broader marketplace to further protect investors from 'distort and short' artists," Cox said in a statement issued July 29, when the order was extended. "Because the circumstances around the SEC emergency order were so unusual, I'm not sure we can gather any real lessons from trading activity during this period," said Susan Grafton, a former SEC attorney now at law firm Gibson Dunn & Crutcher in Washington.

After the naked short-selling ban expires, Grafton said, "I think there's curiosity about whether there will be any changes in trading, but I haven't heard any specific concerns." The SEC's staff "does not have a basis for determining that the 19 companies remain especially vulnerable to the illegal 'distort and short' schemes that the emergency order prevented," agency spokesman John Nester said Tuesday. Spokeswomen for both Fannie Mae and Freddie Mac declined to comment.

Advocates for smaller banks and investment firms have been urging the SEC to expand the ban on naked short selling to cover additional financial companies. Analysts and government regulators blamed aggressive short selling for exacerbating the recent plunge in Fannie Mae and Freddie Mac's stocks, as well as that of big investment house Lehman Brothers Holdings Inc. The SEC's announcement of its order followed a 13 percent drop in the price of Fannie shares and a 22 percent plunge in Freddie's on July 10, when a news report said the government had begun contingency planning in the event the companies failed. The next day, Freddie shares plummeted 33 percent at one point and Fannie stock lost 29 percent of its value.

The shares of Fannie, Freddie and the other mortgage companies generally have gained since the SEC's initial announcement on July 15. But shares of regional banks and investment firms nationwide have continued to be targeted, according to the American Bankers Association and other industry advocates. Fannie Mae shares fell 38 cents, or 4.5 percent, to $8.02 in Tuesday trading, while Freddie Mac dipped 23 cents to $5.37. Shares of major investment banks covered by the SEC order also were lower, amid general weakness in the financial sector. Bank of America Corp. shares fell $2.25, or 6.7 percent, to $31.13, and Citigroup Inc. dipped $1.28, or 6.5 percent, to $18.54.


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