FSA burns hedge funds
The Financial Services Authority has this morning burned a few hedge funds and short sellers.
The City watchdog's clampdown on short-selling during rights issues has led to sharp rises in the share prices of HBOS and Johnston Press, both of which are in the middle of the process of raising new capital through rights issues, and of others - including the builders Taylor Woodrow and Barratt - which are thought to have been considering rights issues of their own.
If this doesn't prevent HBOS's £4bn issue of new shares being dumped on its nervous underwriters, nothing will.
But there's a bigger point: if you want evidence not only of the irrationality of markets but of individual market participants, the FSA's squeeze on the hedge funds is it.
As I mentioned in my blog on how short-selling is damaging the financial health of our banks, there was an opportunity here for the big institutions that look after our long-term savings to turn off the tap that allows short-selling - and in the process of turning off that tap, to help themselves and their clients.
Hedge funds that short-sell shares depend on their ability to borrow the relevant shares from giant insurers and pension funds (short-selling is selling stock you don't own, in the expectation that the price will fall and you will be able to buy the stock back for less than what you sold it for).
But although the giant insurers and pension-fund groups receive a fee for lending shares, they and their clients are damaged by the short-selling facilitated by the lending - in that during a time of market hysteria, of the sort that exists right now, a fall in a company's share price caused by short-selling can lead to a significant increase in its cost of capital, which can do it permanent damage.
In other words, the process of lending shares by a pension fund or insurer can lead to a permanent fall in the value of those shares, to the detriment of the pension fund or insurer - and more germanely to the detriment of their clients (that's you and me, by the way, or those of us saving for our retirement).
Which is why the FSA spoke to the big pension funds and insurers and suggested that the best way to curb the worst excesses of short-selling would be if they voluntarily stopped lending the stock.
And what's extraordinary is that these big institutions refused to do so.
That's quite shocking. It makes them look short-termist and thick.
Perhaps they should now put in place their own code of practice to restrict stock lending during a rights issue - because surely it would be more of an indignity to have that forced on them by the FSA, as it implies this morning that it will do.
More pressing perhaps is a serious financial issue for a number of hedge funds.
The FSA has announced that they have precisely a week to reduce their short positions to less than one quarter of a percentage point in companies that are trying to raise capital with a rights issue.
If they don't, their shorts will be disclosed for all to see - and they'll be vulnerable to attempts by other hedge funds to push up a relevant company's share price and thus generate losses for competitors with short positions.
If the short-selling hedge funds are mashed in what might be described as bull raids, they're unlikely to attract much sympathy.