Unethical or stupid?
Thursday, May 1, 2008/
Banks involved in stock lending might not be doing anything illegal, but they are certainly carrying on in dumb way. MR BANKER
By Mr Banker
Your correspondent is completely uninformed as to corporate ethics and morality so he has no view as to whether stock lending ought to be banned by the regulators.
However, as the employee of a major bank I am knee-deep in dumbness and permanently surrounded by stupidity – I am therefore eminently qualified to make an assessment against those criteria.
By way of background…
“Short selling” is when a sharemarket punter bets that the price of a share will fall. The shorter commits to selling a share that they don’t own, at a point in the future. If the price is lower by the time they have come to settle the sale they make a profit; if the price has risen they make a loss.
Stock lending is when the owners of shares rent out the title to their shares. Mostly the owners are nominee companies operated by banks that actually hold the shares on behalf of others, such as superannuation funds.
Why would someone “borrow” shares? The borrowers are shorters who want to hide their shorting from the market.
Back to the issue at hand.
Imagine that a (probably devious) hedge fund manager approached the bank manager for Mrs and Mr Plumber from Petersham, whose home is mortgaged to secure a home loan as well as their business lending.
The hedge fund manager explains that they believe that the houses in Mrs and Mr Plumber’s street are considerably overvalued and wants to borrow the certificate of title so they can make a secret bet without anyone knowing.
The bank manager replies:
“Not on your nelly. My customers will be upset with me if I helped you trash the value of their house and besides which I actually do a lot of lending in that street so if prices fall I‘ll have more problems.”
To which the weasel-like hedge fund manager responds:
“No, I’ve spoken to Mr and Mrs Plumber and they say don’t mind.”
The highly-principled bank manager ripostes:
“Then you haven’t explained it properly. Sod off.”
The devious hedge fund manager tries again:
“No really, I promise that I explained it properly and that they understood and I also promise that I won’t do anything at all to force values down because my interest in the outcome is driven by academic interest only and not the prospect of an absolutely massive payout.”
To which the bank manager replies:
“That’s good enough for me, here you are.”
Moving the analogy to one side, how much will the banks (as nominees for the large shareowners) lend to the shorters?
For punters who believe that a stock will rise and want to gear up, then (Chris Murphy aside) banks will typically lend 70% of the purchase price, leaving a buffer of 30%.
However for shorters, the bankers will require a buffer as low as 5%.
So lenders want more security from borrowers who believe in the value of their asset and clearly won’t do anything to undermine the value of the security that they have provided, than they do from borrowers who believe an asset is over-valued and who have an incentive to trash it.
Which leads your correspondent to the conclusion that stock lending is not the worst thing in the world, but our banks are carrying it on in a really dumb way – but perhaps that’s not really surprising considering that they are after all, banks.
For more Mr Banker blogs, click here.
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