Short-Sale Bans in Europe: "Back to the Future!"

Location Date: 
August 12, 2011

Here we go again. As we discussed in earlier blog posts, European banks have a very symbiotic or perhaps "parasitic" relationship with their governments. The banks own debt issued by EU member states - and the French banks, in particular, own a lot of Greek debt. (see Arrow Q2-2011 letter)

This morning, Q2 GDP in Greece was at -6.5% and France came in at 0%. Everyone knows that Greece is insolvent no matter what spin or "structure" you want to wrap it in. Ergo, French banks have serious issues and this is reflected in share prices. Everyone knows that they need to recapitalize themselves and like the debt they own, the longer they wait the more investors fret. But not to worry, it is all the fault of those short-selling, rumour-mongering hedge funds picking on the poor banks again. Stop the short-selling, and you will stem the share slide.

Unfortunately, if 2008 is any guide, the "short-covering" rally will be temporary and then we will simply get a buyers' strike. Companies that are over-levered and poorly managed will not be improved by a 14-day short-selling grace period. I think this will actually hurt markets in that investors and traders will likely look to short indices as an alternative, thus putting pressure on all industries and sectors.

AIMA CEO Andrew Baker released a statement this morning on the subject, stating "Short-selling is a legitimate market practice which helps capital markets function effectively. It was only last year that the Committee of European Securities Regulators, the predecessor to ESMA, recognised in an official report that 'legitimate short selling plays an important role in financial markets. It contributes to efficient price discovery, increases market liquidity, facilitates hedging and other risk management activities and can possibly help mitigate market bubbles'."

In my opinion, a simple "uptick" rule and ban on "naked" short-selling (that is where no borrow actually is in place) is all that is needed.

Jim McGovern