Short-sellers didn't cause this crisis - the government and bankers did

Short sellers are only taking advantage of the underlying problem, writes John Stepek. The banks made wildly irresponsible loans all through the property boom, and now that the bubble has popped, they are in serious trouble.

You know the story of the Emperor's New Clothes. It's an amusing tale of how a ruler's greed and folly and the madness of crowds are punctured by the nave and pure honesty of a young boy. I suppose you could say that the moral of the story is - "the truth will out".

But I always thought there was something about the fairytale that didn't quite ring true. I finally realised what it was a few years ago when I read a similar folk tale from Singapore.

In it (or one version at least), a young lad takes the Raja and the local population to task over a clearly deluded scheme to boost the local economy. Instead of thanking him heartily and running the Raja out of town, the crowd chucks him off a cliff into the sea. The moral of that story is "no one likes a smart-alec."

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

And the world's short-sellers are rapidly finding out to their cost, which of the two tales is the most accurate reflection of human nature

An update on ETF Securities

By the way, just before we get into today's email, if you're among the investors affected by the freeze on trading in some of ETF Securities' ETC products, I talked to their chief operating office Nik Bienkowski yesterday and got some clarification on the situation. You can read the update here: An update on ETF Securities.

Short-sellers aren't to blame for the banking sector's problems

It's time to "clean up" the City, says Gordon Brown. He's going to rush forward better rules to protect whistleblowers, apparently and crack down on "irresponsible behaviour" in the financial markets. After all, he says, "we don't want these problems occurring in the future."

The FT reports how his noble words have roused the party's left-wing. Labour MP John Cruddas said: "In the wake of casino capitalism and with the onset of recession, the state is the only means society has of protecting itself from the destructive forces of global capitalism."

It would be hilarious if it didn't make you want to weep. Bankers may well have acted as if they've been sitting in the casino during the boom years. But it was a state-owned casino, with governments as the croupiers, and central bankers behind the bar giving out free booze.

This Government built its reputation for economic "stability" on soaring house prices and nothing else. It was happy enough to point to this growth in "wealth" (not "debt") as evidence of its competence all through the boom. And the reason that banks were able to lend as freely and as stupidly as they did, was because central bankers pushed interest rates so low. And who were central bankers working for? The Government, who set the inflation target too high, at a time when prices were being pushed lower a healthy development - across the world by globalisation.

But of course, it can't be the Government's fault. So now we have a witch-hunt against the nearest available target short-sellers. Yet, if you really want to protect whistleblowers, you should embrace short-sellers. Here's why.

Short-selling's a risky business. When it goes right, you can make a lot of profit. But when it goes wrong (as it clearly has today, given the rapid surge in the FTSE 100 and elsewhere), you can end up owing far more than your initial stake. So it's not something to be done lightly. Unlike many active' fund managers, who just buy what everyone else is buying, a short-seller has to pick their targets carefully.

So when a short-seller takes an interest in a company, you can bet it's got problems, or that it's about to run into problems. It's no coincidence that the most shorted stocks in the run-up to the UK recession have included retailers, newspapers, and of course, banks.

The point is that the shorts are just taking advantage of the underlying problem. The banks made wildly irresponsible loans all through the property boom, and now that the bubble has popped, they are in serious trouble. In a perfect world without politicians, there'd be no problem with short-sellers taking advantage of that in fact, the banks are only getting their just desserts.

The real spivs' behind the financial crisis

If Alex Salmond and the like want to attack spivs', how about the spivs who were cheerily selling young couples interest-only mortgages at six times their joint income? "Don't worry about interest rates, love, you'll be able to remortgage to a better deal in a couple of years' time. And don't worry about the capital you can always start paying that back once you can afford it. Besides, the house'll be worth a lot more by then."

Those unlucky homeowners are now staring negative equity and rising mortgage payments square in the face, and the truth is it doesn't matter a damn to them who owns their debt, because they can't pay it anyway. Banning short-selling won't help them.

But then, all that dodgy dealing was going on back in the good times. And when times are good, no one wants to hear the warnings, or to let anyone spoil the party. And unfortunately for short-sellers, when times turn bad, most people would rather throw the smart-alecs off a cliff, than admit that maybe they got it wrong.

Our recommended article for today

Commodities will rise again

It has been a brutal couple of months for commodities investors. But recent falls have been driven mainly by forced selling, and the long-term fundamentals remain strong.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.