It is clear from the credit crisis that shorting is one of the many things that governments and regulators do not understand about financial markets. In September, the US SEC, the UK’s Financial Services Authority and several other regulators banned shorting of financial stocksin an attempt to stop the stock markets from deteriorating further and to help protect the capital of financial firms.
Several weeks on, stock markets are still volatile, and the stock prices of financial firms are still falling. It was a stupid move by regulators that will return to haunt them. Pointing the blame at short-sellers was misguided. Are short-sellers to blame for the demise of Lehman Brothers? Or was Dick Fuld and the hands-off oversight of the regulators to blame? Was HBOS pushed into the arms of Lloyds TSB by short-sellers? It is unlikely. Yes 5% of that stock was borrowed but its stock price was driven down by selling, not short-selling. HBOS, Merrill Lynch, Wachovia, WaMu, Dexia, Fortis – these are all household names held by retail investors, pension funds and institutional investors; these investors were sellers of these financial stocks, and they were not short-sellers.
As surely governments and regulators must be aware, short-sellers eventually have to buy in. Banning shorting might have caused a rush buy-in that temporarily bounced the market up but it does not stop selling, as we have seen since.
Those that pressured regulators to stop short-selling have emerged as hypocrites. The banks and asset managers that have been lamenting the fall in the share prices of financials have been making large amounts of money from lending stock to hedge funds. Morgan Stanley, probably the world’s second-biggest arranger of short sales for hedge funds, reportedly called up the Federal Reserve demanding that something be done to stop short-sellers. And who benefits from the returns of hedge funds that use shorting strategies? Increasingly the pension funds and insurance companies that invest in hedge funds, and ultimately, therefore, the masses.
Those now jumping for joy that the “evil shorters” have probably been run out of business are naïve. The very notion that hundreds of billions of dollars are being used to short financial institutions is ignorant. Pure financial shorters do not exist. There may be some specialist long/short global equity financials and some macro players who had sizeable positions but most hedge funds are diversified. If hedge funds close, it will not be thanks to these bans but rather because of the crisis affecting the prime brokerage industry and lower leverage.
It is perhaps plausible that regulators were aware that shorters were not to blame, but rather than the finger being pointed inwardly, which would have led to a greater crisis of confidence among people on the street, it was deemed preferable to pretend to eradicate an imaginary enemy.
But there will be a price to pay. Industry associations such as AIMA, the MFA, and Chanos’s coalition of hedge funds have serious clout, and were not consulted before shorting was banned. Cutting out these bodies will have lost the FSA and its global counterparties respect. The SEC has always been criticized for its handling of hedge funds so there will be no change there and, if reports are correct, the Commission is about to lose its regulatory hold to the Federal Reserve. The FSA, on the other hand, has always been praised for its openness to hedge funds. That respect will have gone. Several large hedge funds were considering leaving the UK because of tax changes – they now have further reason to go.
