It’s the Short-Sellers – Do the Math

I just turned on the TV to find the Money Programme is appropriately and coincidentally discussing the VW bear squeeze when there quote “was a huge transfer of wealth from the hedge fund community to Porsche”!  Worth a look on iPlayer if you missed it.

What caught my eye today was, first, the Guardian’s front page story that Darling is unhappy (maybe he raised an eyebrow) that the ban on short-selling was reintroduced.  Watching UK bank share prices plummet since the ban was lifted on Friday, I’m hardly surprised.

But then I read Nils Pratley’s often excellent column.  He notes, en passant that:

“… there is very little evidence that short-selling has been taking place in significant volumes since prohibition was lifted last week.”

What??  I could have sworn that I read yesterday (Wednesday 21st) in the very same newspaper that positions had been declared.  After a bit of a rummage I found the Market forces column where, indeed:

“… the banks were again the dominant feature of the day [Tuesday], with Lloyds Banking Group losing 20.2p to 44.8p on worries that it could be nationalised. Barclays fell 15.1p to 72.9p, while Royal Bank of Scotland saw an early bounce peter out and closed down 1.3p to 10.3p. A couple of new short disclosures were issued, with Landsdowne Global edging its bearish position in Barclays up from 0.25% to 0.26% and Paulson declaring a 0.79% short in Lloyds.” [my emphasis]

0.79%!!!  I’m just an ignorant punter and maybe I’m missing something – and the only known unknown I can come up with is whether this was partly a pre-existing position dating from before the short-selling ban – but 0.79% is a huge number of shares to sell, and would definitely move the price dramatically.

Why do I say this?  Well, if I look up Lloyds on Yahoo! Finance, I see that the share price right now is 49.10p and the market cap is £8.03bn.  That is there are approximately 16bn – that’s b for billion – shares in circulation.  Good old Yahoo! (whose figures I assume have some kind of reliability), also tells me that daily average volume of Lloyds shares traded over the last 3 months has been just under 40,000,000 (several times more over the last few days – but then that’s the problem).  40m/16bn is 40/16,000, or 1/400, that is, around 0.25%.

So, over 3 trading days (Friday 16th, Monday 19th and Tuesday 20th) Paulson (whoever that is) alone has built up a short position equivalent to around 3 average days normal trading!  OK, the Government made an announcement on Monday which was bound to increase volumes, but even so, selling 0.79% of the shares would be more than sufficient to disturb the supply-demand equilibrium that normally exists in the market.

We’re supposed to believe that holders of the shares have sold out for various reasons (and they must have reasons, since it’s normal when the price of something falls for fewer people to sell it and more to buy) – somehow they suddenly believe that the UK banks are about to be nationalised, or they are worried about Monday’s announcement, or they are freaked by confusing and contradictory statements by ministers and officials (what’s new?), or by Gordon Brown’s “angry at RBS” grandstanding for the electorate – but what has to be borne in mind is that all these justifications are post facto rationalisations (does Taleb emphasise this point?).  Even random movements in share prices have to be somehow justified by financial reporters. The media has to contruct a narrative, random pieces of information are simply not digestible.

What are the facts?  Well, I saw much of the announcement by Brown and Darling on Monday.  It was technical and detailed but if anything supportive of bank share prices, and certainly made nationalisation less likely, nor more, in that it announced a number of measures short of full state control.  OK, it was a bit of a surprise, and there are some uncertainties, but nothing to provoke many different shareholders to suddenly take a loss.

And do you suppose fund managers, say, carefully manage their portfolios for years just to dump bucket-loads of shares at a massive loss at the first sign of trouble?  (Lloyds shares were trading for over £1 as recently as last Friday – the first bank share price to suffer was Barclays which fell by 25% that afternoon).  No, of course not.  Most investors would wait for more definite information – if the price did plummet it would be in thin trading.

So I’m arguing that the sellers were not primarily holders of the shares, but speculators.  Why would they be selling short?  Well, lot’s of reasons:

• They may really believe the banks are going to be nationalised, and are putting their highly-leveraged money where their mouth is.   Now we already have a problem – you need to employ a lot less capital to short shares than to hold them.  A short-seller can easily outgun a good honest shareholder with similar financial resources.  Even another speculator using options or CFDs to gain similar leverage would be unable to directly move the share price.

• They may be hoping to draw in other short-sellers in order to make a Ponzi-type profit (when those last into the market take the loss).

• They may be hoping that share-price  falls will self-fulfil an irreversible event, such as nationalisation or dilution due to a forced fund-raising at low prices (or ejection from the ERM in the case of the currency markets!).  This is where I get really uneasy about short-selling.  Because if the aim is to force an event, the decision about when to unwind the position doesn’t come into it.  This introduces an asymmetry (apart from the leverage) as longs have to decide both when to buy and when to sell (in the case of the UK banks that would have been a couple of years ago).  Force the price to zero and you don’t have this problem.  Under certain circumstances deep enough pockets, or the ability to attract other speculators give the short-seller an advantage.

This is where media management comes into it, and the whole business starts to get a little whiffy.  For example, someone called Jim Rogers has been talking down the UK in general and sterling in particular.  Why now?  Presumably this guy’s fund is short sterling, but shouldn’t his every utterance be qualified?  Doesn’t he have inside knowledge of market positions?  I’m very uncomfortable about this sort of thing.  It did prompt another idea though: it occurred to me that shorting the banks and forcing their share prices down may be a cheap (and even profitable) way of exploiting a short position in sterling, since if the banks were nationalised thsi would be very bad, perhaps even Icelandily disastrous, for the currency.

Of course, the best media management draws in others who have the same point of view for different reasons, in this case, John McFall, who somehow finds himself an off-message head of the Commons Treasury Select Committee in these momentous times.

And there may be more subtle media manipulation going on.  I mean, if the Russians and Georgians, Israelis and Palestinians are at it, why shouldn’t managers of multi-billion dollar funds get in on the act?  It’s not as if they can’t afford it and it’s not as if there isn’t plenty of expertise out there for sale, unlike Kaka, to the highest bidder.  Why, for example, do we suddenly find out, today of all days, about an unhelpful clause in Barclays agreement with its Middle East investors?

I’m very pleased to have achieved a negative rating when commenting on few days ago on a column by Vince Cable in the Mail.  I’m currently at -4!  Great!  But I stand by all the statements I made, especially the one point on which I agreed with the man who will share a large portion of the blame (not least for egging the Government on to set the unfortunate Northern Rock nationalisation precedent) for the car-crash the UK economy will become if all the banks are nationalised, or even one of what are very large organisations indeed.  Yes, Vince and I (as befits fellow SPS graduates) agree on one point: it was lunacy to lift the short-selling ban.

Personally I can’t see how the UK can nationalise the banks, the short-sellers seem to have made further equity fund-raising impossible, so other than giving the Government some more prefs (with a less punitive coupon than before – why give overseas banks an advantage, they cause even more problems?), the authorities will just have to muddle through, burying the biggest black holes in the banks’ balance-sheets, in time-honoured fashion.