How likely would congress be to ban short exchange traded funds (ETFs), in particular funds that aim to short the financial industry?

As of today, the ban on naked short selling of 19 protected financial stocks is set to expire in 30 days from July 21, 2008, so the ban is not permanent.

Jimmy Lathrop for Seeking Alpha points out that the market makers on the exchanges where the 19 stocks trade are able to execute short sales without breaking the rules. This ban only effects naked short selling, not short-selling, period.

Short ETFs use derivatives and do not short the actual stocks, but instead use futures and counterparty swap agreements in order to achieve their leverage.

The idea of stopping short selling within financial stocks puts the government in a bind. We all know the banks have a problem. So Lathrop asks, “How do you decipher between opportunists looking for a cheap buck, and market participants using a historic tool to set a true market price without distortion?”

If Congress were to establish regulation on this market, there would be a certain amount of transparency for market players to have a clearer picture of the risk they are about to endure.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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