I guess it’s time for me to stop being amused when China does not-especially-Communist things, but still, I giggled a bit when I saw that China is liberalizing its short-selling rules at around the time that Western Europe is tightening its rules. Because freedom on the march, or whatever, though as David Keohane at FT Alphaville points out, China’s short-selling thingie is pretty solidly in the state-sponsored capitalism camp.
It’s not entirely clear to me why China is liberalizing its rules; the answer seems to be “so that financial institutions can make more money charging hedge funds for stock borrow,” which I guess. Another possible answer could be loosely of the form “China is tired of Americans and Australians making all the money shorting Chinese fraud companies and wants domestic investors to get a crack at that action.” More generally, if you have capital markets beset with fraud, you want to provide incentives to catch that fraud. And if you’re looking to get foreign capital and are worried about embarrassing incidents, it’s nice to have at least some of those incidents taken care of within the family – by Chinese speculators catching Chinese frauds – rather than being exposed to the wider world.
Of course the same incentives exist in Europe, where companies with pretty opaque balance sheets bounce around not telling you whether their balance sheets are filled with fake trees, in the form of Greek bonds, or real trees, in the form of, I don’t know, Swiss francs. Which is why lots of people aren’t that keen on short selling bans on financial stocks in Europe. And yet European regulators seem to disagree. Let’s strain ourselves to justify that a bit shall we?
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The first study of the impact of the SEC’s July 15 emergency order restricting short selling in nineteen financial stocks shows that the order probably had a detrimental effect on markets. While the order was in effect, the bid-offer spreads in the protected stocks widened and the stocks became more correlated with broader market movements.
The study comes from Arturo Bris, a professor at Lausanne’s IMD business school. He finds that volatility in the 19 stocks decreased while bid-offer spreads increased, while both measures remain stable for non-protected stocks. This suggests that the SEC order was genuinely interfering with market pricing. What’s more, overall market efficiency was harmed by the market. In an efficient market, stocks move less with broader indexes and more on information about individual firms. While the order was in effect, the prices of the 19 firms became more correlated with the broader markets.
Perhaps more interestingly, the study also questions the widespread impression that the 19 financial stocks were being victimized by naked short-selling. The average ratio of short sales to overall trading in the 19 stocks was only one tick higher than for other financial companies, for instance. Prior to the order, the largest volume of shorting activity hit firms that were issuing convertible bonds. This implies that most of the short sales in these stocks were not done by rumor-mongering speculators but by convertible bond arbitrage funds.
The cynical will hardly be gob-smacked by the report. Of course the emergency order made the markets less efficient and interfered with pricing, they’ll say. Isn’t that what it was intended to do?
(via Seeking Alpha)
The emergency measure meant to protect shares of 19 financial companies from abusive short-selling is set to expire tomorrow. The SEC has said that it will not extend the rule. Instead, it plans to propose a new rules on short-selling that will apply across all US equities markets. But that rule could be months in the offing.
It’s not clear what effect the emergency rule had. Some market participants say the requirement that short sellers manually locate and pre-borrow shares slowed down short trading. Others say that shares in every one of the 19 protected companies–including mortgage giants Fannie Mae and Freddie Mac and Lehman Brothers–were widely available for borrowing, and that any slow down was minimal.
The new rules could take a variety of forms. A reintroduction of the old uptick rule, which required short sellers to wait for stocks to move higher before they added a short position, is unlikely. But some say a modified uptick rule, essentially a circuit breaker that would prohibit shorts if a stock was rapidly declining, may be introduced. Other possibilities include mandatory disclosure of short positions and the application of some version of the emergency rule to all shares traded on US exchanges.
One dark-horse possibility emerged recently in Pakistan, where some investors recently urged that a ban on all stock declines be adopted. Freddie Mac chief executive Richard Syron could not be reached for comment.
You’d think that if we’ve learned anything from the past few waves of financial crisis, we’d have learned that shorts sellers play an important role in financial markets.
Shorts can check otherwise unbridled financial enthusiasm, improve price discovery and have often pointed out accounting chicanery at powerful public companies. Shareholders and management are incentivized to overlook or cover-up problems. They want stocks to go up. Regulators often lack institutional incentives to investigate wrong-doing.
But shorts, like John Paulson of Paulson & Company or Jim Chanos of Kynikos Associates, can make fortunes by uncovering hidden problems. In short (sorry), they are providing the market with a valuable service–let’s call them positive externalities–all while pursuing profit.
Nonetheless, we haven’t learned this lesson at all. Today the Financial Times reported that the UK securities regulator, the FSA, is going to impose new disclosure rules on short sellers who take positions on the shares of companies undertaking new share issuances.
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How bad must things be up in Armonk?
It’s usually a sure sign of deep trouble when a company blames short-sellers or runs crying to lawmakers for protection. MBIA has announced plans to do both. It’s asking lawmakers to investigate or curtail “the unscrupulous and dangerous market manipulation activities of short sellers,” according to a written copy of testimony it plans to give to the U.S. House Committee on Financial Services that Reuters obtained.
What really has MBIA’s knickers in a twist is that scheduled appearance of Bill Ackman before the committee.
“MBIA notes that Mr. William Ackman is appearing on the hearing on February 14th as an ‘industry expert.’ Mr. Ackman is in fact not involved in the industry in any capacity except as that of a short-seller, and, accordingly, MBIA questions the characterization of Mr. Ackman’s expertise,” the testimony says.
Scandalous. Everyone knows that short sellers cannot be experts. Only corporate management count as experts. Just ask Enron. That damned Jim Chanos guy got up in their face, and he wasn’t even in the energy trading business. They really showed him.
MBIA to urge curtailing short sellers [Reuters]
Jim Chanos, the legendary hedge fund manager who shorted Enron when the company was flying high, is predicting a “huge spike in defaults” of leveraged loans, according to Reuters.
“I don’t know what crack pipes these guys were smoking, but some of the valuations were absolute madness,” said Chanos, speaking to hundreds of investors, referring to private equity firms and their portfolio companies.
Short-seller Chanos sees raft of new opportunities [Reuters]
Business Week’s Matthew Goldstein reports that federal investigators are nearing the end of their 18-month probe into the “murky world of stock lending,” and it looks like it’ll be employees from Wall Streets stock-loan desks who’ll be going down.
The folks who’ve undergone the most scrutiny work for Bear Stearns, Janney Montgomery Scott, and Morgan Stanley. On June 18, Morgan Stanley vice-president Peter Sherlock, who’d been with the bank for 13 years, resigned after his name came up in the case. His lawyer, John Wallenstein, declined to say why his client had taken an early retirement, but did confess to “know[ing] there is an investigation by the Eastern District of New York” and “know[ing] the SEC is looking at it too.”
Earlier: Trouble In Stock-Loan Scheme Town
Criminal Probe Snares Morgan Stanley VP [BusinessWeek]
This month, the number of shorted shares on the NYSE reached 3.1% of the total number of shares traded on the exchange. This is the highest percentage since 1931 (just to give you a sense of how long ago that is – in May of 1931 the Empire State Building had just finished construction). The bulls may carry the day though, as shares of the S&P 500 are trading at only 17.8x earnings on average, which is a far cry from the 32.8x earnings S&P 500 shares were trading at on average at the end of the last bull market. As short sellers continue to hold firm, they may continue to eat it, according to Bloomberg:
Hedge funds that focus on shorting lost 35 percent from September 2002 through the end of April, according to the Credit Suisse Tremont Hedge Fund Dedicated Short Bias Index. That compared with an 82 percent gain for the S&P 500 in the same period. The funds are the worst performers this year among 10 hedge fund strategies tracked by the Credit Suisse/Tremont Hedge Fund Index, dropping 1.1 percent.
Short Sales Break Record on NYSE; Market Bulls Get More Bullish [Bloomberg]
Everyone knows that you’re nobody until somebody
loves you stalks you slips a rohypnol in your drink accuses you and your kind of being criminals (it’s true). A “number” of people in Wall Street’s securities lending business may earn that kind of recognition in the very near future: Business Week’s Matthew Goldstein reports that federal prosecutors in Brooklyn are close to charging current and former Street employees with “taking part in a complex kickback scheme that may have collectively cost the financial houses and short sellers million of dollars in higher and unnecessary fees.”
Three Sal Bonpensieros are already cooperating with prosecutors. Past and present stock loan desk employees from Bear Stearns and Morgan Stanley are being the most thoroughly investigated. Prosecutors also have their eye on Goldman (and former Goldman) employees, as well as Janney Montgomery Scott, Merrill Lynch and Nomura Securities.
No doubt this has left many short-sellers on the train back from Greenwich this afternoon with mixed feelings. On the one hand, finally someone is uncovered for criminality in the short-selling business and it turns out they weren’t working for a hedge fund. Take that anti-naked short-selling conspiracy theorists! On the other hand, it means that all those brainiac business school grads at the hedge funds were being taken to the cleaners by a bunch of guys at the stock lending desks of Bear Stearns and Morgan Stanley! Talk about humiliating.
The Crackdown on Stock-Loan Schemes [Business Week]
FINalternatives said it best: “Just because you’re in the process of shutting down after losing $6.5 billion doesn’t mean the Feds will cut you a break when it comes to naked short-selling.”
Amaranth Advisors has agreed to pay $716,819 to the SEC to settle charges that it shorted five stocks before their secondary offerings, and then covered the sales with the securities bought in those offerings. Amaranth didn’t admit or deny the charges, an in a letter to its investors, noted that the naked shorts had nothing to do with the meltdown last September, which result from bad natural gas trades and a lack of bad weather.
Wrote founder Nick Maounis, “The trades that are the subject of the settlement represent a variety of trading errors or misunderstandings of the application of the rule.”
Amaranth settles short-selling case with US SEC [Reuters]
Amaranth Hit For Naked Shorts [FINalternatives]