Sunday, 23 November 2008

Short-circuiting short selling

The only reason I can conceive for the government’s failure to stem the demise of banks’ share prices by banning short-selling is the risk it poses to hedge-funds who might incur catastrophic losses and feed the widening of the contagion we call the financial crisis. Does anyone even remember that the source of all this was sub-prime? 

I fret at the lack of policy response in this one area because clearly by failing to prevent short-selling they risk a different kind of broadening of contagion. Namely the progressive toppling of the once-mighty global banks such as Citigroup and then inevitably the toppling of the consumers. They look left they see a giant rock; they look right and are only greeted by a hard place. 

Clearly, the government would be compelled to rescue the banks with public funds but how big would the bailout be for Citigroup? And if rescued who might be next on the short-sellers target list. 

Despite all the flak laid upon the financial sector the real villains must be those whose bonuses rely on bankrupting banks. 

Why does short-selling of the stock of a once healthy bank cause a bankruptcy? Quite simply because everyone watches the stock price to indicate its health and as it approaches 0, queues start forming outside its branches by customers panicking they will lose their hard earned savings. 

In a sentence short-selling causes a run on the banks and thereby circuitously vindicates the strategy of short selling. Someone needs to short circuit short selling’s self prophesising aims.

 

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