After Bear Stearns’ demise, each new crisis in the banking sector raised alarms about short-selling. When the share prices of Goldman Sachs Group Inc. and Morgan Stanley dropped sharply on 17 September, Morgan Stanley CEO John Mack declared in a memo to his staff, “Short-sellers are driving our stock down”. And in testimony before Congress on 6 October, former Lehman Brothers Holdings Inc. chief executive Richard Fuld singled out “naked” short-sellers as one of the culprits in the firm’s 15 September bankruptcy.
Naked short-selling occurs when a short-seller tells his broker to sell shares that the seller has not yet borrowed. On 17 September, SEC ruled for the first time that naked short-selling amounted to fraud. On 28 October, Japan banned naked short-selling in its markets through 31 March 2009.
In the UK, the campaign against short-sellers also goes back to March, when the Financial Services Authority (FSA) said it suspected that “false rumours” linked to short-selling led to a sudden drop in the share price of HBOS Plc., the country’s biggest mortgage lender. An FSA investigation found no evidence of abuse.
Bank robbers
In September, when Lloyds TSB Group Plc. agreed to buy HBOS for one-fifth of its value a year earlier, both Archbishop of Canterbury Rowan Williams and Archbishop of York John Sentamu continued to blame the short-sellers, with Sentamu calling them “bank robbers”.
The 2007 annual report of the Church of England shows that its £5.5 billion (Rs43,890 crore now) of assets included a £34.5 million position in HBOS and £40.4 million in Barclays Plc., whose stock also plunged in September and October. The Church of England Pensions Board at the end of 2007 managed another £850 million, including £8.5 million worth of HBOS shares.
In response to the furor, FSA banned short-selling of the stocks of banks, insurance companies and securities firms from 18 September through the rest of the year. A day later, SEC imposed its own ban on short sales of 799 financial stocks. It later added 170 more companies, including International Business Machines Corp. and Sears Holdings Corp. The SEC ban, after one extension, expired on 9 October, six days after passage of the $700 billion (Rs34.86 trillion) US bailout plan for the banking system. In the time the ban was in effect, Standard & Poor’s 500 Index lost 17.7% of its value.
Short-sellers say they are scapegoats for the real villains in the meltdown.
“The shorts who warned about the real estate bubble have been proven right,” Fleckenstein says. “Now the government has changed the rules overnight. They’re blaming the shorts and bailing out the ones who lost all the money and almost took the financial system down.”
Manuel Asensio, 53, president of New York-based Mill Rock Llc., says he and his brethren keep the stock market honest by going after companies with rotten accounting, dubious business plans and excessive debt. “There was a legitimate reason as to why the financial stocks went down; it was mispriced securities on their balance sheets that caused the problems,” he says. Mill Rock is a hedge fund that holds long and short positions in equities and invests in distressed bank loans.
After mid-2007, when two Bear Stearns hedge funds collapsed, investors had every reason to believe financial shares would decline, says George Feiger, CEO of investment manager Contango Capital Advisors Inc., which oversees about $2 billion in Berkeley, California.
Expression of doubt