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Sunday, November 18, 2007
The 'Naked' Short Sell and the 'Who Cares' Individuals

What Price To Pay?

There is significant talk in the U.K. press this week about the destructive efforts that a few hedge funds are having on the U.K. economy by significant volume short selling of shares in order to make a few individuals a profit. The Times Online ran an article on November 14 about Northern Rock Bank which has been the subject of significant short selling and 'naked' short selling by 'speculators'. This has drawn the Bank of England into a fight against these individuals, but has severely cost the taxpayer. While the Bank of England has been trying to rescue Northern Rock, some individuals at the same time are trying to rip it apart. Estimates are that the Bank Of England may have to put as much as 40 billion pounds in Northern Rock to keep it healthy. In older times had someone sold their country short like this they would have been spending their last night in Tower Hill and not somewhere with more than five stars at the front entrance.

The London Stock Exchange (LSE) issued a public warning this week that some hedge funds must significantly reduce the speculation and 'naked' short selling of Northern Rock shares. 'Naked' short selling is where a financial institution or individual sells a volume of shares they don't even own with the hope that they will fall in value so that they can profit from the difference if they do. As an analogy, it is like selling a car to someone over the phone, and hoping people are forced to take trains because of future traffic jams, thereafter de-valuing the car you just sold. You can now buy the car back at a lower price, even though it never existed to begin with.

What the LSE is very concerned about is that the whole process of short selling and 'naked' short selling is starting to become a way of life in the markets and this process is totally destructive to the U.K. economy. At the height of the Northern Rock crisis, it was estimated that 30% of its shares were being shorted, and some people started shorting the bank significantly before the Bank's problems were publicly announced, which itself has initiated some insider trading investigations. Extremely confidential information from Northern Rock's debt financing negotiations was leaked to traders so that they could short the bank's stock before anything was publicly announced. There were probably also leaks to the press once the short trades had been secured. All of this is being thoroughly investigated by the authorities as the debacle has so damaged the British public. It is possible, that had the information remained confidential, Northern Rock could have negotiated interim financing without the run on the banks deposits that ensued.

In summary, a few hedge funds pick their targets and then go after them like hungry vultures at a 'drive thru' with total disregard to the national impact of their actions. This gives the other hedge funds a bad name, and what the LSE and the Bank of England are concerned about is that if nothing is done soon about this destructive process the consequences to the U.K. economy will be severe. There have been calls for the Financial Services Authority to 'sharpen their teeth' and go after the insider trading and other abuses, and most of the honest players can't wait to see the FSA and the authorities adopt a tougher stance.

Without a fix to this overly speculative element of the finance sector, some financial analysts believe it will not be possible to acquire enough capital to promote new long-term investments in renewable energy and ecosystem restoration companies required to save the planet in time.

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