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Main Content
Sold Short?
As markets around Europe plummeted during the first weeks of August, some Eurozone members took the decision to ban short-selling
Was this the correct decision? And how will it impact on the potential for future crises?
Sympathy for bankers is something of a rarity in 21st century Europe. A substantial financial collapse precipitated by reckless lending, followed by a sovereign debt crisis made more grave by the exposure of some of the continent’s well-known banks, has meant that most citizens treat their moneymen with open disdain, some finding them more distasteful even than politicians or – worst of the lot – journalists. A recent survey in the UK found that some of the brightest and best students had decided against careers in the banking sector – put off by a stigma now so synonymous with the profession that potential recruits feel that ‘banker bashing’ will be an inevitable downside to doing the job.
It is unlikely, then, that many people on the continent would have been bothered by the news that France, Belgium, Italy and Spain all decided to introduce temporary bans on short-selling two weeks ago, bringing the total number of Eurozone countries having banned the practice to five if one includes Greece. Most citizens – if they had heard the news at all - would have concluded that what they get up to on their own August holidays are far more important than what goes on in Europe’s financial centres and anyway, the financial services industry had brought such things upon itself –haven’t they lived it up for years in those big glass monoliths of theirs? Isn’t it time they were brought back down to earth with the rest of us?
Anyone with a basic knowledge of short-selling may well have welcomed the news that it had been banned, given the amount of coverage that there has been in recent years about the negative effect it can have on markets, making them volatile just when stability it most needed. In fact the practice itself is relatively complex, but essentially involves traders selling assets borrowed from a third party with the understanding that the seller will buy them back from the buyer at a later date, thereby incurring a loss if they go up in value but making a profit if they go down. Of course, this means that the seller is hoping that the value of the assets in question will decrease – a galling fact when one considers the lengths to which governments have gone in recent years, taking on cosniderable debts and releasing vast amounts of liquidity to stave off this very eventuality. The idea that a slick trader could make his fortune out of such a situation renders some citizens incandescent with rage. Indeed, for others the situation is even worse – rumours abound that traders are inclined to gang together and target certain stock to induce a fall in its value – after all, what’s the point in simply hoping for a collapse when you can bring one about through your own guile? Anecdotal evidence would also suggest that the ban on short-selling is a good thing for economic reasons as well as moral ones; markets in four of the Eurozone countries – France, Spain, Belgium and Italy stabilised almost as soon as the measure was announced and some even saw a small bounce. Greece, sadly, is in such turmoil over its sovereign debt that the overall effect has been negligible.
Yet, such facts conceal both an economic and regulatory reality; the continent’s bankers and traders deserve at least a degree of sympathy over the ban on short-selling, not least because they are forced to suffer due to a crisis not of their own making and are made scapegoats for inadequacies which exist elsewhere in the financial system. Of course, as with many of the world’s ills, it is not difficult to assign at least some blame to bankers for the market jitters which led to the introduction of the ban. These were caused in no small measure by the possibility of Greek government default on its debt – a debt caused by banks lending money they knew the Greek government would struggle to find. But they have also been extended indefinitely by the failure of any decisive EU response to the current problem – either with a full programme to support Greece with Eurobonds or with a candid declaration that Greece will be allowed to go bankrupt. Much blame therefore rests with politicians and perhaps even more with the EU-appointed auditors who allowed the country accession to the Eurozone in spite of its patent failures to meet the required criteria. The ban on short-selling therefore appears opportunistic; it allows EU politicians to appeal to populist sentiment whilst also deflecting attention away from their own failures. Nor is this an isolated phenomenon; since the financial crisis of 2007 a plethora of new regulations and rules have been introduced some of which may have made the markets safer – the banking stress tests of the European Banking Authority being such an example – but many of which seem to be part of a wider paradigm designed firstly to punish bankers but also to ensure that no one could accuse regulators, and by extension politicians and governments, of complacency.
Nor is the economic evidence against short-selling overwhelming enough to consider a ban an effective strategy. Clearly, the markets stabilise after the measure was introduced, but results in a situation where the true value of stocks is impossible to know. As with stress tests for banks, what better way to test the value of assets than to see how they perform when put under strain. Moreover, they provide a useful outlet for stocks which have been overvalued and can often help prevent share prices from becoming overinflated. In the same way as volcanoes allow for the release of lava and hazardous gases bubbling under the earth’s surface, short-selling allows for a fall in prices. Of course, both are unpleasant and dangerous when taking place, but in the long run they allow for a great deal more predictability and safety.
Such realities however, will be of little consolation to traders in Paris, Madrid, Rome and Brussels, all of whom have, temporarily at least, lost out on the chance to partake in activities which some have even argued constitute a vital part of the free market. However, it may mean that selling the idea of sympathy for bankers becomes a little easier and that EU citizens’ patience with their politicians gets just that little bit shorter.