Are they reaping what they sowed?
So the FSA is banning the practice of short-selling? From someone who covered the hedge fund industry for two years this couldn't have come soon enough.
Soon after graduating in 2005 I found myself in London as a derivatives journalist, covering the complex, crazy and somewhat shady world of hedge funds, where I wrote about high net worth individuals who thought nothing of investing £1 million or more in the latest craze, such as emerging markets, oil, gold, water, wind – the list goes on.
Yes, if there is money to be made, hedge funds will try to make it. One major strategy they use is shorting stocks, or betting that a company will go down in profit and pocketing the change.
How does it work? Well let’s say I thought that oil was going to go down in price. I'd call up someone who owns some oil shares, such as a pension fund or an insurance company, and ask to borrow them for a week, promising them a small profit when I gave them back. These people take a 'long' view of their shares and see them gaining in value over time, and so are more than happy to oblige because they would at least get a bit of a return if they fall in value.
So then I'd sell them on the market – even though I didn't own them. If all goes to plan they would fall in value. Then I'd buy them back using the money I sold them for at the much lower price, and then return them to the lender with a little commission on top. They'd get their shares back and profit from the commission, and I'd be quids in.
However, this practice has been blamed for causing real market turmoil over the past week. It is claimed speculators working for hedge funds made more than £1 billion by short-selling HBOS shares in June and July. But while some people claim it's not short-sellers that drove the prices down, the fact remains that the system is open to abuse. Who is to stop speculators spreading malicious rumours about the state of the company, to drive
its price down and make a quick buck?
So that's why I welcome the FSA's temporary ban on short-selling. While I agree it does have its uses in a normal market as it takes over-valued companies down a peg or two, in the current climate there is no need for it – it's causing nothing but panic and fear, and has the potential to hit us all in the pocket.
Hopefully this is the turning point in the credit crunch and there is light at the end of the tunnel.
Liam Tarry is the Staff Writer at Moneywise