Wednesday, September 24, 2008

The Archbishop of York says something stupid... this case, about modern financial markets.

But note the double incompetence on the part of the reporter, who (a) doesn't know how to keep from injecting editorial opinions into what's supposed to be a straight news story and (b) doesn't understand what short sellers are doing. Here's the quote I mean:
Sharp falls in the price of shares in banks have been blamed on short-selling by speculators hoping to drive the prices down further.
Actually, speculators aren't generally "hoping to drive the prices down further," because, unless they are George Soros or somebody with similarly obscenely deep pockets, a position large enough to drive down a price is usually a position that risks bankrupting the speculator if he fails. Short sellers don't typically sell stocks short in order to try to make them fall -- they sell them short because they believe the stock is priced irrationally high and they think the stock is going to fall whether they sell it short or not. They're just trying to make some money out of what they think is going to happen anyway.

Now, it is true that short sellers will occasionally try to drive prices down a little bit -- but this typically happens in a very special situation. Amateur "technical traders" have a habit of coming up with rules to tell them, "If the price falls to level x, then sell," or, alternatively, "If the price rises to level y, then buy." Being amateurs, they typically pick very obvious prices (levels of "support" or "resistance," for example). But that means that once prices fall to level x, lots of amateurs will try to sell all at once, and this will cause the price to drop several points very rapidly; while if they rise to level y, they'll all try to buy at once, and this will cause the price to jump. So if you're a professional day trader, as you see prices getting close to level x, you do a quick check on the buy pool, and if you think the market's thin enough, you try to sell the pool enough to push the price down to level x. This is called "running the stops" (because when you tell a broker, "Sell if the price falls to x," or, "Buy if the price rises to y," those are known as "stop" orders).

But here's the point -- if you succeed in running the stops, then as soon as those amateurs' sale orders pour in and the price makes its quick little several-point fall, you immediately buy back your short positions, because you know that there's no real fundamental reason for that market drop, just an artificial hiccup due to the presence of amateurs in the market. In other words, short sellers do occasionally sell stocks in order to make them fall -- but when they do that, they're just trying to make them fall a few points for a few minutes. And that doesn't come within a million miles of putting the bank into insolvency.

What happened with HBOS has nothing to do with the running of stops, and you have to be pretty damned stupid, frankly (or else as dishonest as a typical Labour politician) to think people were selling stock short in order to make its price fall.

1. Rumors hit the street that HBOS had secretly asked the Bank of England for emergency funds, which, if true, would have meant that HBOS had been falsifying its financials and trying to disguise critical problems in its portfolios. As a result, shares fell 17% -- which would have been an eminently reasonable fall (fairly modest, actually) had the rumors actually been true.

But here's the thing about rumors: if they're false, the price snaps back as fast as it went down, and anybody who short-sold the rumors on the way down and is still short, loses his derriere. I speak from personal experience, having once had a heavy short position in the British pound -- with stop orders to switch me from short to long should the price rise to a certain level carefully chosen to be well away from any obviously runnable stops -- on the day that a rumor swept the CME floor that President Bush the First had been assassinated. I got killed as the dollar collapsed; my stops got hit and I went short the dollar; and five minutes later President Bush showed up live and healthy on television and I got killed again as the dollar rebounded.

So the only way in which The Evil Short-Sellers could have caused this particular problem at HBOS, would have been if those particular short-sellers had first sold the stock short and then deliberately started the rumor. In other words -- and I know this isn't difficult for most people but if you're an Anglican bishop or a Labour politician I'll have to ask you to pay careful attention and read very slowly -- it wasn't the short-selling that made the price drop; it was the rumour.

Oops, sorry, some of those words had more than one syllable. For the benefit of Anglican bishops and Labour politicians I will try it again:

The bad men who sold short did not make the price fall. It was the lie that made the price fall.

(And if that's still too hard for the good Bishop to follow then I give up.)

2. After that, the price started bouncing around because even though HBOS's officials were saying, "No, no, we're fine," most people in the market did not trust HBOS's officials. That would be because, not to put too fine a point on it, CEO's lie a lot. (Especially if they have taken the precaution of donating LOTS of money to Senators -- see Mac, Freddie and Mae, Fannie.) But here again, two points:

A. This is the executives' fault. If executives did not lie, then when they said, "We have plenty of liquidity," their stock price would go back up.

B. Anybody who short-sold in the middle of that volatility, either got lucky and got out with a quick profit while it was still volatile, or else lost money when...

3. Lloyds TSB came in and offered to buy out HBOS at a price (232p/share) 5.4% higher than the highest price (220p/share) at which HBOS traded during those volatility days, and a whopping 265% higher than the lowest price. That means that a short-seller who bet a thousand pounds on his short-sell and didn't get out in time lost -- at best -- 54.55 pound, and could have lost as much as 1,636.36 pounds. Yes, that's right, the unlucky short-seller could have lost his entire investment plus an extra 636 pounds.

In fact, it's even worse than that, because I ran the numbers on the (unrealistic) assumption that the short-sellers were using no leverage whatsoever -- i.e., that they gave the people from whom they borrowed the stocks the full current value of the stock up front. If they were, say, 50% leveraged, then you can double their losses -- which is to say, the unlucky fellow who short-sold at the bottom and didn't put a stop-loss order in to protect him on the way back up, would have lost his original thousand pounds plus 2,272.73 more.

But then on the other hand, in fact it's not that bad because no sane short-seller would have sold short at 88p without having a stop-loss buy order in with his broker at, say, 95p. Plus I don't know the rules for the British stock exchanges specifically, which may not allow leveraged short-selling...

Look, my point is that short-selling is extremely dangerous, and people lose lots of money selling short all the time.)

See, here's the bottom line: either HBOS is really worth 275p, or it isn't. Say it's "really" worth 250p (that is, if God were buying it, He'd pay 250p and not tuppence more). Then in that case the Lloyd's shareholders got about a 7% discount on their newly acquired HBOS shares, which does indeed mean that HBOS's shareholders wound up unlucky in the deal -- but it's the Lloyd's shareholders who made the money, not the Evil Short Sellers.

But what if HBOS really does have problems, and a year from now the Lloyd's shareholders realize to their chagrin that anything more than 200p was a rip-off price for HBOS stock. Then in that case, current HBOS shareholders will have gotten a 14% premium, paid for by Lloyd's shareholders -- but it'll be the HBOS shareholders who made the money, not the Evil Short Sellers.

So, time to sum up:

Lemme tell you a secret, Right Reverend Sir. HBOS didn't go down because of short-sellers. And your use of the term "bank robbers" is intemperate, uncharitable, slanderous jackassery.

With all due respect, of course.


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