The temporary ban, aimed at helping restore falling stock prices that have shattered confidence in the financial markets, takes effect immediately.
"This will absolutely make a difference," said Peter Cardillo, chief market economists at Avalon Partners. "Short sellers are going to have to cover their positions very heavily."
Short sellers borrow stock with the aim of selling it, then buy it back at a lower price, hoping to pocket the difference. The commission said short sellers add liquidity to the markets during normal conditions, but recent unbridled short-selling has contributed to the recent tailspin in the stock market.
"The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets," said SEC Chairman Christopher Cox in a statement. "The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets."
Cox said the action "would not be necessary in a well-functioning market," and is just one of many actions being taken by the government to jump-start the embattled financial markets.
The SEC also said it would temporarily ease restrictions on companies' ability to repurchase their stock, and force money managers to report their short positions in certain stocks that are not included in the 799 banned companies.
Some market observers have also blamed short sellers for the punishing declines in bank stock prices over the past few days. Critics of short sellers have argued that some had been spreading rumors about a company while "shorting" the stock in order to drive the price lower.
"In the marketplace, we need both sides of the equation," Cardillo said. "But the relaxed regulation of the SEC has led to abuses of short selling that have destroyed many, many companies."
As panic began to permeate the financial markets, many investors took short positions on already battered financial companies regardless of the news that came out of the companies or the government. For instance, investment banks Morgan Stanley (MS, Fortune 500) and Goldman Sachs (GS, Fortune 500) reported better-than-expected earnings Wednesday, but dropped significantly in trading.
"This decision will squeeze the shorts," Cardillo added. "Now, if there is any good news, shorts will have to cover."
The ruling comes after the SEC decided Wednesday to ban the practice of so-called "naked" short-selling, in which investors short the stock without actually borrowing it.
On Thursday, Britain's Financial Services Authority also temporarily banned short-selling for financial companies. The SEC said it is consulting the FSA in the matter.
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