Bears in the Hedges

Bears don’t prowl anymore, with so many badly wounded beasts about, they lurk in the hedges from where they pounce. Lehman Brothers was mauled so badly by Greenlight’s David Einhorn, a top-performing hedge fund manager whose largest short position has been in Lehman, that they replaced President Joseph Gregory and the feisty and flamboyant Chief Financial Officer Erin Callan.

Now just as HBOS issued rights, news that hedge funds have heavily shorted the bank has sent its shares below that offer price.

HBOS shares tumbled below the rights issue price yesterday as it emerged that a hedge fund run by one of the industry’s best-paid managers had taken a gamble on their decline.

Harbinger Capital, the fund run by former Barclays Capital head Philip Falcone, revealed it had built up a major short position of 3.29pc in Britain’s biggest mortgage lender.

How can they resist? The bank has over $2.5B in write-downs and its recent cash call was less than spectacular. On the Street, write-downs and cash pleas smells like blood, so it’s natural for hungry bears to short HBOS:

HBOS unveiled a £100 million writedown on its equity investments in Britain’s battered housebuilding sector yesterday as it formally launched its £4 billion cash call via a posted prospectus to two million private shareholders.

It came as Andy Hornby, the Edinburgh-based bank’s chief executive, admitted that, historically, there was a greater proportion of rights issue shares left with underwriters where issuing companies had bigger private shareholder bases.

Proof positive that Britains three big banks have friends in high places is the recent daylight shed on the positions of hedge funds by their version of the SEC - the Financial Services Authority:

Six other funds disclosed short positions in Bradford & Bingley today: GLG Partners LP, 2.81 percent; Steadfast Capital Management LLC, 1.23 percent; Steadfast International Ltd., 0.84 percent; Oceanwood Global Opportunities Master Fund, 0.45 percent; American Steadfast LP, 0.4 percent; FIL Ltd., 0.25 percent.

The FSA imposed new rules June 20 that require disclosure of short positions of more than 0.25 percent of stock for companies that are selling new shares in rights offerings.

Blaming short sellers and lack of confidence for the collapse of a company is a tried, but tired practice theses days, it worked with moderate success on Bear Stearns, but failed spectacularly with Lehman Brothers.

The complaints about short-sellers fall roughly into two camps: first, specific allegations about their motivations; and, second, an inchoate unease about the very idea of betting against a company’s success. The shorters are accused of preying on companies and driving down their stock through collusion, issuing negative research to manipulate the stock and spreading rumours. These activities are in any event illegal. Overstock.com and Biovail, a Canadian drugmaker, have both sued short-sellers, claiming that the traders tried to drive down their stock prices through such methods.

However, says Professor Bris: “This sort of market manipulation is no more characteristic of short-sellers than of bullish investors.” His views are echoed by other academics and market participants. For their own part, short-sellers complain of a double standard: why should a view that a company’s shares are likely to fall be inherently less valid, and more worthy of suspicion, than a view that the shares will rise? One short-seller says: “I can buy GE long and go on TV and ramp the shares all I like and no one says anything, but as soon as I short I am spreading false rumours and a danger to the whole financial system? It doesn’t add up.” Like most others, he does not want to speak publicly – in part, he says, for fear of opprobrium.

That’s right; bears sniffing the wind did not cause the more than $2.5B in write-downs and force a $7.9B rights issue. The same thing happened on the way up as the credit bubble inflated and none of the companies involved complained. If mom and pop retail investors want to pile on the short side in a free market who is to say otherwise? Well it may be the inside elites who’s fortunes are tied to share price. Is it coincidental that the new FSA rule comes now and applies to banks issuing rights?

The unprecedented move by the Financial Services Authority (FSA) follows slumps in the stocks of companies – particularly banks – that have recently completed or are in the process of issuing new shares.

The government’s stated position is that the free market result, volatility, is unwanted.

“As a result, there has been severe volatility in the shares of companies conducting rights issues.

“This is potentially damaging not only to the issuers in question but also to confidence in the overall fairness and quality of the UK market.”

But as has been pointed out, to protect the few elites they rock the boat for everyone else.

“As the market hears more and more about smart investors taking large positions against HBOS, they could be tempted to do the same and put in shorts,” said Mamoun Tazi, an analyst at MF Global Securities Ltd. in London who is “neutral” on the stock. “This could create the opposite to what the Financial Services Authority wanted and result in much higher volatility in the shares.”

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