Market Abuse Is Rife, Just Not in Short Selling: Mark Gilbert

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Market Abuse Is Rife, Just Not in Short Selling: Mark Gilbert

Commentary by Mark Gilbert

June 26 (Bloomberg) -- The Financial Services Authority has been investigating U.K. trading for evidence of what it calls market abuse. The regulator hasn't been able to make the charges stick. That's because it is looking in the wrong direction.

Run a six-month chart of the share price of HBOS Plc, the U.K.'s largest mortgage lender. The FSA wants us to mistrust the decline in the first two weeks of this month to a record low of 249 pence. It alleges dodgy dealing by malicious short sellers, who borrow stock and then spread mendacious gossip to drive a company's share price lower, pocketing profits along the way.

That's nonsense. Anyone who hasn't been living in a cave this year could come up with a laundry list of genuine reasons to short the shares of a mortgage lender -- especially as HBOS is in the middle of trying to raise 4 billion pounds ($7.9 billion) of fresh capital from its shareholders at 275 pence per share.

Want to see market abuse in action? Check out how HBOS popped higher from that June 12 low, when a 27 percent surge in just four trading sessions put clear blue sky between where the company traded and that all-important rights-offer price. All important, that is, for regulators trying to avoid the debacle of a failed fund-raising exercise by a leading British financial institution, and the underwriters on the hook to ensure HBOS gets its money.

Market Manipulation?

So what sparked the rally? Great news about the U.K. housing market? Revelations that the loan book at HBOS was in better- than-expected shape? A mysterious rebound in what John Maynard Keynes dubbed animal spirits?

None of the above. The FSA itself kick-started the revival by announcing on June 13 that short sellers would have to disclose their trades during rights offers, and that it might block the stock lending that enables investors to bet on a drop.

If that's not market manipulation -- coming after HBOS slumped below its offer price, with no investor consultation and no prior notice, and prompting a 14 percent, one-day jump in the beleaguered lender -- I don't know what is. The regulator has since had to issue no less than three so-called clarifications of its new rules, which came into force on June 20.

It isn't the FSA's job to attempt to bolster a faltering share sale by moving the goalposts on a Friday. It is ridiculous to suggest that hedge funds, the usual suspects that the authorities corral into a line-up whenever a market goes the ``wrong'' way, are somehow acting abusively by speculating that HBOS isn't worth as much as its management says it is.

Bearish on Bear

Think back to the collapse of Bear Stearns Cos. earlier this year. Skeptical shareholders proved absolutely justified in dumping the stock, amid regulatory mutterings of wrongdoing and malfeasance by investors. Moreover, its death certificate was signed by its peers, not by short sellers, after the banking community decided it had zero faith in the securities firm.

Why should investors be anything but bearish about U.K. mortgage lenders, which are cranking up their interest rates, demanding higher deposits and trying to shrink their home-loan businesses in a huge vote of no confidence in the outlook for real-estate values? Last week, HBOS almost doubled its prediction for how much U.K. house prices will decline this year, to 9 percent from 5 percent previously.

The backdrop to the difficulties HBOS is having is instructive. It was beaten to market by Bradford & Bingley Plc, Britain's biggest lender to owners of rental properties. In April, the mortgage company said it didn't need fresh capital. In May, it tried to raise 300 million pounds by selling shares at 82 pence, a 48 percent discount to the then-prevailing price.

Slash and Burn

By this month, a 48 percent slump in profit and a collapsing share price forced the company to slash that offer to 55 pence, and to sell a 23 percent stake to U.S. leveraged buyout firm TPG Inc. By June 2, the shares were trading as cheaply as 60 pence, down 75 percent in the year. This week, Bradford & Bingley is the target of a takeover bid by Clive Cowdery's Resolution Ltd.

Bradford & Bingley ended last week with a market value of about 423 million pounds, making its misadventure an embarrassment. HBOS is 25 times bigger, so a lot more is riding on its share sale. And it's not clear that the FSA medicine is even working; the shares closed below the rights-offer price at the end of two trading sessions this week.

The authorities can't keep wrapping the banking industry in cotton wool just because it is the banking industry. Banks, like children, have to be allowed to eat dirt, bruise knees, and fall off the swings occasionally. By propping them up, the authorities are abusing the market.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net
Last Updated: June 25, 2008 19:01 EDT