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With politicians everywhere blaming hedge funds and short sellers for the financial crisis, I guess it was only a matter of time before short selling was completely banned. Over the past week, gradual steps have been taken to make it harder. First naked short selling (selling a stock without even borrowing the paper so you could cover having to buy it later) was banned. Then the US banned all short selling of financial stocks on Friday. Everyone else followed. And now the Australian market has banned all short selling, fearing an avalanche of overseas investors swamping the Australian market.
I’ve been trying to work out all week what I think of short selling. On balance, I agree with this pundit, Douglas Kass, in the FT. Short selling didn’t cause this crisis, it just made it happen faster. But there are a few problems with short selling, particularly if you don’t have to disclose – there are huge motivations to create negative rumours if you have a short position. And they are easier to believe than positive rumours. But I doubt that short selling was solely responsible for Macquarie Bank’s 50% bounce in stock price this last week – there would have been plenty of genuine punters out there terrified that it was next.
So in normal times, the sensible thing would be to enforce the rules (many of which already existed) against naked short selling, and require disclosure. But in today’s panicked state, with enormous volatility being exacerbated by shorting, there is a real risk that a company will go under because the higher volatility, magnified by the availability of short selling, puts them under some key ratios for a short period of time. So I’m reluctantly agreeing with the short selling ban. Not a sensible long term decision, though.
And I think that those listed fund managers and banks which, over the last year, have taken steps to stop lending their own stock, because it encourages the short sellers have been purely acting from self-interest – a well regulated market does include short sellers.
The US Federal Government’s effective takeover of Fannie Mae and Freddie Mac may or may not end their lives as independent institutions. From my point of view, though, I hope it does. Far from being, as some would say, the guarantors of a stable housing market in the USA they have instead acted as that worst of government institutions in the market – exploiting their quasi-government status (and the government bond ratings that come with it) to act as maniacs with meat-cleavers.
Implicitly using the public purse (through the belief, now proven, that the government would bail them out) for private gain (dividends to shareholders) they have long used their ability to issue debt that the Fed would accept at the discount window to undercut fully-private institutions, stifiling the development of a full mortgage market in the US. Institutions wanting to gain exposure to the US housing markets either had to accept the sorts of rates that came out of a deal with Fannie or Freddie (and the losses on their own funding rates that resulted) or get into the lower quality mortgages that Fannie and Freddie would not (or could not) touch.
Possibly worse they also consistently tried to enter new markets, again also using their quasi-government status, to issue many types of new instruments that then distorted those markets. Their regulator, unlike the ones for fully private firms, was weak and did not require them to hold anything like the amounts of capital any other financial institution would have. This gave them yet another advantage and further distorted the markets.
The solution? In one of the (few) calls I have ever made for more legislation (or even nationalisation), Congress should move to fully nationalise both of them, paying out the shareholders the full market price as of Saturday, and then liquidate them both. Sell off all of the instruments they hold, repay the debt and then take any loss (or gain) that results.
While they are at it also wind up Ginnie Mae, the Federal Home Loan Banks, the farm credit banks and Farmer Mac. These children of the New Deal have long outlived any usefulness they may have had in the context of the 1930s and now only exist as means of distorting the markets and providing government pork to the farming community – who are, with few exceptions and the possible exception of the Europeans, the richest farmers in the world.