SEC Bans Naked Shorts of Fannie, Freddie

Securities and Exchange Commission Christopher Cox on Tuesday said the regulator planned to crack down on naked short-selling of Fannie Mae(FNM) and Freddie Mac(FRE), helping to lift financial stocks in afternoon trading.

Cox said in testimony to the Senate Banking Committee on Tuesday that the agency will require short-sellers to borrow shares of the two government-sponsored mortgage giants and broker dealers including Lehman Brothers(LEH), Goldman Sachs(GS), Merrill Lynch(MER) and Morgan Stanley(MS) before selling them. The new restrictions are called for under a temporary emergency order that expires in 30 days.

Short sellers borrow shares and sell them in the hopes the stock's price will fall, allowing them to pay back the lower price. "Naked" short sellers do not borrow the shares first, allowing them to drive down the stock's price without regard for natural supply and demand.

Cox's comments come as the financial markets slipped and then recovered on Tuesday amid sobering comments on the economy from Federal Reserve Chairman Ben Bernanke. Treasury Secretary Henry Paulson also provided testimony and further clarification on the proposed federal bailout of the two mortgage giants.

The NYSE Financial Sector Index, which fell more than 4% on Tuesday, more recently was up fractionally to 5,720.16. Fannie and Freddie were both down around 18%, but Goldman, Lehman and Morgan Stanley were rising. Merrill was down fractionally.

"[A]s events in recent weeks have demonstrated, many financial markets and institutions remain under considerable stress, in part because the outlook for the economy and thus for credit quality, remains uncertain," Bernanke said during prepared remarks for the Fed chairman's semiannual monetary policy report to Congress.