The consensus among the financial community – excepting, perhaps, asinine bank boards and their ineffectual directors – seems to be that no, the FSA does not know what it’s doing.
There was – we understand – no international coordination on the FSA’s shorting ban. Rather, the regulator’s executive drew up the plans “in response to market events” and presented them to a specially convened FSA board meeting which ratified the move. The plan was made public straight afterwards.
Some thought process.
What were they reacting too? The fall in HBOS’ shareprice? How so? Only 3 per cent of market cap was on loan. Shorting in HBOS – as with most other financials – has fallen massively this week. They must have been reacting to something else.
London’s huge hedge fund community wasn’t even consulted – in spite of the fact that this rule would most obviously impact them. The below is from statement from the Alternative Investment Management Association (AIMA):
AIMA regrets that the latest rules banning short-selling were implemented without notice or consultation.
AIMA is not alone in doubting whether the recent bans on short-selling of financial stocks taken by financial regulators – the FSA in the United Kingdom and the Securities and Exchange Commission (SEC) in the United States – are likely to achieve the intended results over time.
These measures have the potential to create several unfortunate consequences, including an increase in the cost of capital for banks, at a time when it is most needed and incorrect pricing of index products, with negative implications for mainstream retail products.
Of course, if you believe the stereotypes, why would you consult? Hedge funds are staffed by evil speculators afterall. Nevermind the fact that hedging – that most conservative of financial strategies- needs shorting to work. Nevermind that shorting is not often used as a simplistic and aggresive bet by evil “speculators” but could be part of a hugely complicated arbitrage strategy that might have nothing to do with financials at all. Nevermind that hedge funds are huge and essential clients of investment banks. Nevermind that it’s precisely the collapse of hedge fund business that sunk Lehman brothers and may yet do it in for Morgan Stanley.
Nevermind, nevermind, nevermind. Clearly.
We haven’t even touched on the fact that over here in the UK, with HBOS openly in merger talks, whatever shorts there were on Wednesday morning got badly burned without the need for FSA intervention. Lex has its own take on how the market regulates short selling by itself.
Bronte Capital spots another unintended consequence of banning short selling:
Last I looked when I was short a stock the broker borrowed the stock (yes, Virgina you do get a borrow) and sold it. They then had cash.
That cash was not available to me – it was pledged to whoever provided the stock to remove or reduce the risk that the stock won’t be returned.
That means it is generally available to the broker (who will generally lend me the stock from their inventory or margin or prime broker clients).
Now there are a few hundred billion of short-sales out there. Probably more than normal – but a lot in almost all markets.
And those short sales produce cash balances of a few hundred billion, most of which are available to Wall Street brokers.
This is all back of the envelope, but we’re clearly talking very large numbers.
A final datapoint, this one from Yves Smith. A ban on financial shorting is not merely a ban on shorting a small section of the market in the US. It’s a ban on a stock universe covering 40 per cent of earnings on the S&P 500.
A quick look at the FTSE in its final hour. It’s up 9.6 per cent. The biggest daily rise in its entire history. On what news?
Are banks safer? Have money markets come unstuck? Are mortgage assets recovering? No, No, No.
Unless the US Treasury really does announce a plan to put taxpayers on the hook to billions of dollars of risky mortgage assets this weekend, this rally will have been utterly unfounded.