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Caught short

Instead of arbitrarily lashing out in response to short-selling, governments should hone coherent policy to apply to all players

• 
• • Seth Freedman
  • guardian.co.uk, 
  • Friday September 19 2008 10:20 BST
  • Article history

As all sage traders know: when America sneezes, the world catches a cold. And, it seems, not just by way of falling prices. Yesterday's inane decree by the FSA, banning the short selling of financial stocks, makes the SEC's decision on Wednesday seem tame by comparison. It is an outrageous abuse of the free enterprise principle. The FSA's intervention is the market equivalent of book burning; utterly unacceptable, yet predictably par for the course in today's climate of fear.

History attests to the fact that financial crises bring out the worst in the masses, and the action taken by the FSA is nothing more than vigilante violence on a national scale. Problems in the economy? Let's find a scapegoat. Too difficult to blame the real culprits? Let's pick on a minority, surround their homes with flaming torches, and drive them out into the wilderness.

While at first blush this may seem a harsh judgment, the mindset behind the public's baying for blood (and the FSA's acting upon it) is no different to mob rule in any other situation, whether economically, politically, or racially motivated. Shock and horror is the order of the day, fuelled by either incomprehension or wilful ignorance, providing the politicians and regulators with given carte blanche to abandon the rulebook and make up a new one on the hoof.

Vince Cable is one man who will feel vindicated by the FSA's capitulation to political demands, having vented his spleen at the hedge fund community for daring to do their jobs: that is, make money for their clients, regardless of whether the market is going up or down. Heblamed "aggressive" hedge funds for "betting against the taxpayer", deploying incendiary rhetoric to paint the fund managers as the root of all of the imploding economy's evil.

He was backed in his crusade by Lord Oakeshott, who opined: "we must think long and hard before ever allowing the short-selling of British bank shares again." Fighting talk from the Lib Dem Treasury spokesman, but talk, which pays scant regard to the proposition that if the banks can't stand the heat, they should get out of the City kitchen, and de-list their fragile shares from the rough-and-tumble market playground.

As a commenter pointed out on my last thread, if short-sellers were as omnipotent as people are portraying them, how come Tesco, GlaxoSmithKline, and other fundamentally sound companies aren't being driven to the wall by short positions? The disease is the mismanagement of the banks' directors; short-selling is simply a symptom.

What's worse, and proves even more the duplicity surrounding the FSA's course of action, is that they're banning precisely those activities upon which the banks have thrived for so long. The traders of Lehmans,HBOS, et al were never shackled in their endeavours to make money out of the misery of other companies; they all profited in spades from shorting weaker stocks when the wolves were at the door. Now, however, when the hunter becomes the hunted, suddenly the law of the jungle applies no more; the FSA has effectively declared banks a protected species.

In a cautionary tale that will – perversely – put gleeful smiles on the faces of shortophobes the length and breadth of the land, the case of the bear-squeezed Volkswagen shares shows that short-sellers aren't immune from getting taken to the cleaners. Thanks to Lehman Brothers' collapse, the VW shares lent by the bank to short-sellers were recalled early as Lehman's traders sought to unwind their positions, forcing hedge funds unwillingly into buying back their positions earlier than they had intended.

The result was a glut of buyers and dearth of new sellers, leading to a massive rally in VW shares. The share price surged 33% in less than a week, causing untold damage to the balance sheets of those betting on a collapse in the price. Will any tears be shed for them amongst Oakeshott, Cable and co? Unlikely; they'll be too busy crowing to their adoring fans after orchestrating their hostile takeover of justice and ethics.

Instead of arbitrarily lashing out at will, the authorities would do far better to hone their policy into one coherent set of principles that would apply to all players in all markets. Imposing massive taxes on excess profits would, at one fell swoop, put an end to the wild and untrammelled thirst for riches that drives traders at every point on the spectrum, whether they're going long, short, or sideways.

As it was put to me earlier: "If you take away their cocaine [in this case short-selling], they'll feed their addiction with speed." In the vacuum left by the ban on going short, 10 other trading mutations will spring up to fill the void. If, however, the FSA's aim is to get the monkey off the traders' backs for good, then far more stringent and across-the-board measures must be applied, and fast. Sauce for the shorting goose must be sauce for the long-trading gander; if that means fettering the entire industry in order to bring much-needed relief and stability to the markets, then so be it.