The parallels with 1929 are growing. The equity bear market has lasted longer than any other since the Great Crash. Wall Street banks are under fire for conflicts of interest and questionable practices. And short-sellers are in the dock again, with long-only funds blaming them for exacerbating market falls and demanding regulatory action.
This time the hedge funds, always the scapegoats whenever markets fall but never when they rise, are bearing the brunt. This has happened after every recent market correction – most recently after September 11.
In 1929 US president Herbert Hoover went to war with market bears, ordering stock exchange authorities to ban short-selling in a move widely seen as helping only to deepen and prolong the 1930s’ bear market.
The theory today is the same: short-sellers are evil people, they have robbed us of our money and they must be stopped. Never mind that it was the market bulls that pushed prices up to such lunatic levels again that losing money was the only outcome.
Even Axa chairman Claude Bébéar, a supposed champion of free markets and head of one of the largest institutional investors, has joined the chorus. He says curtailing hedge funds’ freedom to borrow would limit market volatility – which, with a Gallic touch, he describes as “irrational, even immoral”.
Other insurers and pension funds are threatening to stop lending to hedge funds and other short-sellers, not least the investment banks themselves, whose own shorting activities tend to be obscured by the media’s obsession with hedge funds. Two big Dutch pension funds, ABF and PGGM, have already done so and have tried to orchestrate a campaign for other large fund managers to follow suit. But this looks ill starred.
There are signs that regulators these days are better informed about short-selling and less likely to engage in 1929-style knee-jerk reactions that could undermine market liquidity and price efficiency.
The UK’s Financial Services Authority backs short-selling. “We see no case for an outright ban on short-selling, a practice which we judge a necessary and desirable underpinning to the liquidity of the London market,” it says. But it is more sympathetic to the need for greater disclosure. It has convened a roundtable for September that will discuss possible moves to increase disclosure, such as publishing data on stock lending as a proxy for short selling.
Hedge funds including Man Group and Dawnay Day are participating. So are the London Investment Banking Association, the Association of British Insurers and the Investment Managers’ Association. Bank of England and SEC regulators will also attend.
Data on stock lending would not capture all short-selling, which can also be executed through spread betting or futures and options. But it would provide much greater transparency. It would also highlight the hypocrisy of investors that publicly berate short-selling while privately earning juicy fees from lending stock. “If people really are so opposed to short-selling, then why on earth do they lend short-sellers the stock in the first place?” asks one broker.
One option for European markets is to copy the US where an investor may only sell stock short if the last price movement in the stock was up. In addition, all short positions in US stocks are disclosed regularly, as they are in Canada, Australia and Hong Kong.
But others have their doubts, pointing out that the uptick rule does not appear to have made the US market any less volatile than its European counterparts in recent months.
They also argue that it is open to abuse. “All an investor has to do is get the broker to buy a tiny amount of stock and then bang a huge sell order through on the uptick,” says one market analyst.
Nils Taube, chairman of investment firm Taube Hodson Stonex Partners, believes greater transparency would be good. “Short-selling improves the quality of the market, but disclosure is important,” he says. “As long as it is disclosed, it is not dangerous.”
FSA officials agree. “Abusive short-selling is wrong,” says a spokesperson. “If we saw it, we would take action.” But she argues that most short-selling is not abusive. Rather it reflects the view of certain investors that shares are overvalued and provides a counterbalancing view against other analysts.
Despite complaints from investors, the FSA’s analysis of market movements suggests no increase in short-selling – with the amount of stock on loan accounting for 2% of market capitalization.
“Short-selling should not be made the scapegoat,” says the spokesperson. “If there was more information, people would be able to draw their own conclusions.”
