Will short-selling ban work to calm markets?

David Cameron is not the only one launching a fight-back. In true French form, the securities regulator is taking the battle right to the door of the hedge funds and banning market speculators from trading in French bank stocks.

“They wanted to test French resistance!” he declared.

“This is our response, as always very determined and it will be so for all those who want to put us to the test.”

Zut alors! But will the action, which has been mirrored by Spanish, Italian and Belgian authorities, have any effect? Well, there are a number of reasons to suspect it could end up doing more harm than good.

They wanted to test French resistance! This is our response. French securities regulator

For starters, it simply looks defensive. We don’t like what the market is doing, so let’s just shut the market down. Yes, it may temporarily stop the rout of banking stocks (Societe Generale lost more than a fifth of its value at one point this week) but it could also send a message that the authorities have something to hide. (If the market continues to dig, it might find out what the rest of us know.)

So the suspicion never really goes away and once the ban is lifted, back come the speculators in their droves.

Are hedge funds to blame?

Secondly, can the market regulators – frustrated and all as they are – really be sure that hedge fund speculators are behind the drastic moves in their banks’ share price? The truth is, the sell-off could simply be ordinary institutional investors who have simply concluded that the risk of holding those stocks, with all the concerns swirling about their exposure to sovereign debt, just isn’t worth it. So you may stop the hedge funds, but you may not necessarily stop the sell-off.

You only have to look at what happened in 2008 when Gordon Brown banned short-selling in the aftermath of the Lehman Brothers collapse. They were worried about the massive share price falls in HBOS, Royal Bank of Scotland and Lloyds.

All those banks (like Societe Generale) issued statements one after the other reassuring the markets of their strong capital positions. Really, they insisted, there’s nothing to worry about. Lehman even brought forward its earnings – showing profits as I recall) by a couple of days to calm things down. But the truth is it didn’t work.

And therein, perhaps, lies the interesting question. Once the market has got hold of something, is it ever wrong?

Even with the ban in place back then, Bradford & Bingley collapsed and HBOS shares sunk so low they were forced into a rescue by Lloyds which in turn needed an emergency bail-out from the British government, alongside RBS.

History has shown us that the market wasn’t wrong there, so if it suspects there’s danger ahead now, should regulators and governments not be listening, rather than trying to shut the noise out?

The one thing you have to conclude though is that the hedge fund/speculator market is too opaque and desperately complicated. The fact the regulators can not be sure who is trading what with whom is a bad indictment in and of itself.

Your view

While much has been done to increase market transparency since the 2008 credit crunch, there is still a way to go. I found these two responses to a tweet I sent out earlier very interesting and they go some way to illustrating the polarised view of speculators.

One said: “Short-selling is the mechanism that prevents constant inexorable market rises, which are followed by tumultuous crashes.” (ie: Leave the hedge funds alone, they are a force for good).

But another asserted the move to ban speculators was: “Shutting the stable door after the horse has bolted. Should be illegal, period.” (ie: Go after them as hard as you can, they are criminals).

You could argue that – like the complex debt securities that fuelled the financial crisis in the first place – if something is clearly so misunderstood, smart as the hedge fund investors may be, should it have a place in post-credit crunch financial markets?

Follow Siobhan Kennedy on Twitter @siobhankennedy4