Short Selling - Argument against

Several Hedge Funds and their industry representative today make thinly-veiled threats that they might consider to move their business away from London if the ban on short-selling the shares of financial service companies is not lifted soon. We had quite a lively reaction from a number of readers and business partners. They argue that this may mean that national regulators would let themselves be pushed into a 'race to the bottom' in terms of regulatory standards. The consequence might then be that international regulations will be introduced to avoid this. In addition, one correspondent pointed out that the argument about the pros and cons of short selling could only be resolved by a detailed forensic analysis of all the transactions involving the shares of banks during the past 14 months. This would have to include equity and credit derivatives and all related off-balance sheet instruments.

Short Selling - Argument in favour

Arturo Bris argues (Wall Street Journal, 29 Sept 2008) that the ban on short sales of financial shares should be lifted. We think that the argument is not convincing. The real question that would have to be asked is: what would have happened to the shares of financial companies if there would have been no short selling? The level of short interest that Bris quotes in the article is truly enormous (19.1 % of outstanding shares in March 2008!). We just cannot accept that this amount of short selling did not have a substantial influence on the level of share prices of banks and investment dealers.
That the market in shares where short selling has been banned after the Lehman collapse is now less liquid should not surprise anyone. It is only to be expected - and maybe desired - that there will be less trading when short sellers are out of the market. They are likely to be the most active market participants - some of them are reputed to have turned over their portfolio up to two times (!!) EVERY DAY.
For an interesting detailed rejoinder to Bris' argument you may wish to read a post on www.deepcapture.com. The blog also exposes the incomprehensible - not to stay stupid - attitude of the SEC with respect to abusive short selling.

Lehman: Short Raiders 1 : Regulators Nil

That is the score in the game of chicken played between the band of short sellers intent on pushing another Investment Bank over the brink and the regulators - in particular the SEC - who fiddle while Rome burns.
Last July the SEC imposed a ban on 'naked' short selling of bank shares which in our opinion was much too weak a measure given the pervasiveness of short selling and the fire power that the raiders have at their disposal. Naked short selling was illegal in any case, so to finally enforce it was just a pathetic gesture.
Financial Institutions are critically dependent on public trust as ALL banks would be bankrupt in a second if all depositors and creditors would demand repayment at any point in time. There was a time when short selling was limited to a small group of sophisticated investors and to market professionals such as NYSE specialists. Now this cottage industry has morphed into a monster that threatens the stability of whatever target the 'shorties' decide to take aim at.
Recent trading volumes in the shares of Lehman Brothers are so enormous that they cannot be simply the result of long-term shareholders deciding to sell. Activity in the shares is more akin to the frenetic buzz normally limited to betting shops. The SEC so far has failed to call an end to this and we fear that the taxpayer will have to pick up the bill when the music stops.
This shall not be construed to be a defense of the actions of Lehman management. That huge bets were made on property-related holdings is testimony to a serious lack of discipline on the part of top management.

Wipe out Fannie Mae Equity and profit handsomely!

Anyone who still has doubts about the ability of the authorities to deal with the fall-out from the sub-prime credit crisis would have been convinced otherwise if he had the chance to watch Bill Ackman pontificating about his proposal to 'recapitalise' Fannie Mae.
It is amazing that CNBC gives a fund manager who happily admits that he is short the common stock and subordinated bonds the platform on which to promote his financial self-interest at a time when the American Banking System (and British?) experiences a severe crisis of confidence.
At least the FSA in the United Kingdom has made a first step towards the restoration of fair play in the markets by making the practice of short selling shares in companies that are in the process of a rights issue subject to (very weak and ineffective) disclosure rules.

Short Selling is a valid practice - but like any good thing it becomes a danger if carried to extremes. Temple Associates is a fervent proponent of Free Markets but this practice can now be turned into a 'weapon of financial mass destruction'. Short Selling in the good old days was confined to market professionals (Jobbers or Specialists) and maybe a few savvy speculators who had very small amounts of money to play with. Now Short Sellers can muster billions, even tens of billions and as a consequence the practice has to be seen in a fresh light.
Short Sellers can initiate a vicious cycle and cause a downward spiral in confidence which is very difficult to reverse. Of course, where there is smoke there is fire. But that does not mean that a business that can be nursed back to health should be pushed over the brink just to satisfy the greed of a few market players.

Kerviel Case: Where has all the money gone?

In all the excitement about the huge losses made by Soc Gen's Monsieur Kerviel and the bank's management one thing never gets mentioned: someone out there has made a whopping big profit out of all of this. Futures in particular are the ultimate zero sum game and where there is a loss there always is a profit. This is no consolation for Societe Generale and its shareholders who are left holding the proverbial bag but it should calm the nerves of politicians, economists and other commentators. Economically not much has happened except that a substantial sum of money has passed hands. Society as a whole is not poorer as it would be if the same sum of money would have been spent building pyramids - or steel plants that turn out to be surplus to requirement once they are finished.