Regulators cannot avoid blame for financial meltdown

Pointing the finger at short-sellers for manipulating the market is misguided - the regulators are at fault, writes Proinsias O'Mahony

GET SHORTY. That's the response of authorities in Ireland, Britain, the US and elsewhere to the market meltdown, with regulators banning short-selling of financial stocks. Market crises tend to induce hysteria towards those who seek to profit from share price falls, and this week has been no different.

Scottish first minister Alex Salmond decried a "well-capitalised, properly funded" institution like HBOS was "forced into a merger by . . . a bunch of short-selling spivs and speculators".

The media joined in, with the Mirrorlambasting Philip Falcone, the so-called Midas of Misery, as a "greedy pig US billionaire who has helped bring HBOS to its knees". "Don't let the spivs destroy Britain," pleaded the Daily Express, adding that "ruthless" shorts had caused the "humiliating demise" of HBOS.

The Mirrorand its ilk would have been better off doing some fact-checking. Short interest in HBOS was only slightly greater than the average FTSE firm, with less than 3 per cent of its shares on loan this week.

HBOS collapsed due to an absence of buyers; fingering the shorts is misguided. Shorting of the US market has also dropped in recent times, contradicting notions of a short-selling surge.

In fact, the manipulation is coming from the regulator, whose actions have distorted the definition of a free market. It also pretended all week that HBOS was "well-capitalised" and could "fund its business in a satisfactory way". HBOS contacted news blogs to trot out the same line. However, UK chancellor Alastair Darling admitted the authorities knew "HBOS had been in trouble for weeks" and the situation would have been "very bleak" had it not been for the Lloyds' takeover. The porkies came from the regulator and HBOS, not from the maligned shorts.

The situation in the US is as ironic. The SEC claims to be "using every weapon in its arsenal to combat market manipulation", a contradiction in terms, given that one of the essential checks and balances of equity trading has been suspended. In 2004, the organisation made a change to rules that limited investment bank leverage. The previous debt-to-net capital ratio of 12-to-1 was lifted, allowing the banks to become leveraged up to 30 or even 40 to 1.

Of the five banks granted this exemption, only two survive. With Morgan Stanley looking for a partner, that number may soon be one. The demise of Bear Stearns, Lehman and Merrill Lynch is directly related to that decision.

No matter, blame the shorts.

The shorts have been the financial detectives of the past 18 months, doing the work that analysts and credit rating agencies were meant to. James Chanos, who unearthed Enron's dodgy accounting in 2001, more recently tackled the conflicted practices of the rating agencies. Last April, David Einhorn gave a detailed explanation of questionable accounting practices that caused him to short Lehmans. The SEC responded by "hinting darkly that he was part of some conspiracy to drive Lehmans out of business, and generally making him feel that he'd pay a price for telling the truth," to quote Bloomberg's Michael Lewis.

In Ireland, analysts last year claimed that market valuations were "discounting armageddon". The Iseq was around 8,000 at the time. The Central Bank governor told us the Irish housing market was headed for a "soft landing" and that house price figures were "more consistent with stability".

Who should investors have listened to? The establishment or the sceptical short-sellers who saw a bubble bursting? This week, the global system teetered on the brink of collapse. Over-priced mortgages for people who weren't asked to provide proof of income and massively leveraged bets have led to $519 billion of writedowns.

Blaming the shorts is nonsensical. US commentator Barry Ritholtz is right when he says the US ban is "blatant market manipulation" and "nothing short of a total panic by people who have no clue what they are doing".

The credit crisis created the short-sellers, not the other way around. Banning the shorts won't prevent a crash. One 2002 report found there was no correlation between restrictions on short-selling and the severity of crashes. The same report listed countries that banned short-selling, including Venezuela, Pakistan, Jordan, Colombia, Zimbabwe and now add Ireland.

Banning short-selling is good for a short-term pop at best. No lasting gains can be had from this doomed attempt at manipulation. Markets rallied fiercely yesterday, but they were poised to do so.

Given the authorities' efforts as revealed in the latest rescue package, the rally may have legs.

If it does last, some will see that as proof that dastardly "spivs" were unfairly holding a sound market down.

That, however, is fairytale stuff.