大象传媒

Short-selling banks

• Robert Peston
• 3 Jun 08, 10:15 AM

Short-selling of shares is one of those City activities that generates a vast amount of emotion.

Quite a lot of people, including senior people in business, regard the practice of selling shares, securities and commodities you don't own as immoral, as a form of heinous speculation.

I don't take that view.

On the whole, I regard short-sellers as making a helpful contribution to the process of setting fair prices for tradable securities and commodities.

When shares, for example, are priced at euphorically high levels, that is just as likely to lead to a serious misallocation of capital resources as when shares are priced below fair value.

So when a hedge fund such as the short-selling specialist Kynikos identified the fraudulently managed US energy giant, , as grotesquely over-valued, and then sold the shares short, that was a public service (albeit one for which Kynikos's founder, , was handsomely rewarded).

And although some gag at the billions trousered by the US hedge-fund superstar from short-selling securities linked to US subprime, is it reasonable to criticise him for profiting from banks' and other hedge funds' stupidity at overvaluing these securities in the first place?

But short-selling isn't always a blameless and harmless activity.

At times like these, when uncertainty about the robustness of the financial system verges on hysteria, short-selling can cause damage to the health of real businesses - with serious ramifications for their respective employees and customers.

Take the case of a bank that needs to raise capital. And there are quite a few of those around the place right now.

When the share price of that bank falls, it becomes much harder and more expensive for that bank to raise the capital it needs.

And that in turn reinforces the downward momentum to the share price, because the prospects for that bank worsen as the cost of capital rises.

What's worse for the bank, the fall in its share price can also spook providers of credit and depositors - which, again, can do serious damage to the bank's profitability and even (in a worst case) its viability.

So short-selling a bank perceived to be vulnerable looks like a one-way bet for hedge funds, a sure thing.

I am not going to hold up as an example of the excesses of short-selling hedge funds, because the worrying rise in arrears on buy-to-let and self-cert mortgages indicates that the short-sellers were probably right to identify it as over-valued.

But it's less clear that the astonishing falls in the prices of and - which are trying to raise humungous sums in rights issues of new shares - are merited rather than the self-fuelling consequences of a dangerous short-selling feedback loop.

So should short-selling be restricted or banned?

That's quite difficult to do in a financial world where shares, securities and commodities can be traded across borders.

But even without the intervention of government or regulators, the owners of these banks - the big institutional investors who manage the long-term savings of millions of us - could more-or-less put a stop to short-selling.

And it's rather astonishing that they haven't put a stop to it.

Most giant pension funds and insurers have to own a bit of HBOS or Royal Bank, for example, because at least part of their funds will track the UK market - and that means owning a slice of our banks.

And if the real business prospects of HBOS or Royal Bank were damaged by the impact on creditors' confidence of a falling share price, well that would do serious damage to the health and wealth of the pension funds and insurers that own their shares.

Here's the important point.

Short-sellers have to borrow shares in order to sell them - and they borrow them from pension funds and insurers.

In a hypothetical case, a hedge fund would borrow a million shares in Megabank for a fee (in effect an interest rate).

It would then sell those million shares at the prevailing market price of 拢8 a share, raising 拢8m in total.

What the hedge fund hopes is that Megabank's share price would then slide.

Let's say it does - to 拢4 a share. The hedge fund then buys a million shares for 拢4m and hands the million shares back to the lender.

Which means that the clever-clogs hedge fund has banked a real cash profit of 拢4m. Nice work.

But note that the hedge fund would be up the creak without a paddle if it was unable to borrow the shares in the first place.

Isn't it slightly odd that insurers and pension funds actually facilitate short-selling by hedge funds?

Surely it would be rational for them to stop lending stock to hedge funds, since in the very act of lending to them they may be undermining the value of the shares they own.

It does seem the height of madness that institutional investors, which are obliged to own shares in the likes of RBS and HBOS for years and years, may be encouraging falls in the share prices of RBS and HBOS and possibly even damaging the long-term prospects of those banks.

Naturally we rang our leading insurers and pension funds to ask whether they were lending out shares in RBS, HBOS and Bradford & Bingley, but mostly the response was a sheepish "no comment".

But I haven't heard back yet from Insight, the fund management arm of HBOS itself.

Can HBOS itself really be encouraging short-selling of the sort that mullered its stock?

I'll let you know, when I know.

UPDATE: Here's the answer from HBOS: it doesn't engage in much stock lending, by virtue of the structure of its fund management business, rather than as a matter of policy.

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