letter to John McFall MP about shorting

13th January 2009

Mr John McFall MP,
The House of Commons,
Westminster,
London SW1A 0AA

Dear Mr McFall.
I read in the press over the weekend that you will be chairing the Commons Treasury committee when it questions hedge fund managers later this month.

I further understand that you are opposed to the proposed lifting of the ban by the FSA on the short-selling of financial institution stocks.

However, I would ask a wider question: why is shorting of any stock allowed?

The traditional answer from those who conduct short-selling is that the practise provides liquidity to the markets. But I’m afraid I find such an explanation unconvincing, self-serving and disingenuous. It is the price mechanism which should provide liquidity, according to the simple laws of supply and demand.

If a share is illiquid (ie those that hold the stock do not wish to sell it) then the laws of supply and demand suggest that if there is a demand for those shares the price should rise until some of those holding the stock are persuaded to sell.

Similarly if shareholders lose confidence in a company’s prospects or in a company’s management team they will sell the stock, and the price will drop until it finds a level at which it looks like good value when it will be bought.

These processes are easily understood. And yet short-selling subverts these mechanisms by allowing hedge funds and others to borrow stock (or, in the case of naked shorting, not even that) to sell.

Let me ask you this, Mr McFall – when else in life can someone sell what they do not own? Quite rightly I cannot sell your house because I do not own it. I cannot sell my friend’s car because I do not own that either. And yet short-sellers can and do sell what they do not own.

Far from creating liquidity to help the markets such a practise actually distorts the markets by warping the normal processes of supply and demand. It is precisely these kind of warped, exotic business practises which have flown the global economy into the side of a mountain and landed us where we are now.

To listen to those who defend hedge funds one would think that such funds sell a stock short and hope for the price to drop. In fact they sell shares in a company – and keep selling – until the price drops. Can you imagine these Masters of the Universe leaving such a thing to chance?

There are many, many companies where double-digit percentages of the shares are ‘on loan’ and being used for shorting. Shorting, by definition, involves falling share prices, thereby harming small investors – and pensioners not least. What kind of Labour government is it which puts the interests of obscenely wealthy hedge fund managers over those of people who have diligently (dare one say ‘prudently’?) saved into a pension all their lives. How would you feel, Mr McFall, if you were recently retired and forced to cash in your pension and buy an annuity with the markets tanked as a result of the bad bets and reckless lending decisions of City whizzkids?

I hope you give the hedgies a very rough time of it indeed later this month. I further hope that the government will legislate to end the practise of short-selling. You may find that nearer the next election your party needs a boost in the polls. Banning short-selling across the board, the accompanying stock market rally and improvements in people’s pension prospects, and the pain and bankruptcy of many hedge funds could prove to be just what labour needs.

Yours sincerely,