UK stock markets

What is short-selling and will the ban have any effect?

THE UK Financial Services Authority (FSA) has banned short-selling on certain shares until January 2009, "to guard against further instability in the financial sector". The FSA has been joined by other regulators in the US, France, Portugal, Ireland, Australia and Russia and others could soon follow. But what is short-selling and why is it regarded as such a problem?

Fiona Pashazadeh

Short-selling, or shorting, is a practice where investors hope to profit from a fall in the price of shares in a company.

To achieve this, the short-seller targets a company that they believe is 'over-valued' on the market and borrows a number of shares from another investor (usually through a broker) for a fee.

These borrowed shares are then sold immediately at the current price, in the hope that the price will fall in the future. If this happens, the short-seller can buy back the shares at the lower price and give them back to the original investor, keeping the difference as profit.

This is yet another example of the way in which big investors use the financial markets to gamble in the hope of making huge profits. Hedge funds (unregulated, private investment clubs for the rich) are one of the main users of short-selling techniques.

When such profits can be made from falling share prices, the incentive to reduce confidence in a target company and drive down share prices is clear.

The practice is also self-fulfilling - if short-sellers are borrowing large numbers of shares and then selling them straight away on the market, other investors will fear that something is wrong with the company in question and sell their shares too, driving down the price even further.

Short-selling is widely seen as a factor in the collapse and subsequent nationalisation of the bank Northern Rock. At one point, it was reported that as much as 30% of Northern Rock shares were out on loan to short-sellers.

As worried people were queuing up outside the branches, fearing the loss of their life savings, members of the hedge fund community were drinking champagne in Mayfair and celebrating the huge pay-offs from their betting strategy.

The temptation to spread malicious rumours to drive down share prices is obvious. In March, the troubled banking group, HBOS, was the subject of a false rumour that it had sought emergency funding from the Bank of England and this saw its share price plummet by 20%. The FSA has since called off an investigation into the behaviour of short-sellers in this case, blaming 'a lack of evidence'.

As we have seen in recent days, HBOS has now been forced into a rescue deal with Lloyds TSB in order to avoid collapse. And again, the speculators were out celebrating whilst HBOS workers were left wondering whether they would still have jobs.

History

Short-selling, and indeed the banning of it, is nothing new. The first temporary ban is reported to have been put in place as long ago as 1609 and another was put in place following the 1929 Wall Street crash.

Such bans can seem as though they are having some sort of effect - as the short-sellers seek to undo their bets, they scramble to buy back the shares they have borrowed, raising the prices and, in turn, increasing market confidence.

But of course, this is short-lived. These extremely limited measures do nothing to curb the greed of the hedge funds and their super-rich clients - it is no secret that they are already looking for alternative ways to make their huge profits.

The real problems of the corrupt and chaotic capitalist system are never addressed and the freedom of the market is never challenged in a way that would make a difference to ordinary people.

The recent hugely unpopular bailouts have led governments to try and create the illusion that they are taking action to stop the profiteers doing as they please and then getting taxpayers money when it all inevitably goes wrong.

But workers will not be fooled by such measures. It is the job of socialists to put forward the alternative - a system based on democratic workers' control and management of the economy, not on the profits and greed of the few.

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In The Socialist 2 October 2008:

Socialist Party editorial

Market madness!