Sub-prime crisis – so everything is all right now!

But unfortunately the banking crisis cannot be blamed on pantomime villains – “spivs in pin-stripes”. It is easy to check on how much short selling was going on by checking on how much of a company’s stock is out on loan at any moment (“naked” short selling – that where the seller does not borrow the stock – is much rarer). According to the monitoring agencies, only 2.75% of HBOS stock was out on loan last week with only 2.9% of Morgan Stanley’s stock being on loan. Hardly enough to bring the banks to their knees. In contrast struggling Washington Mutual has 24% of its stock out on loan: but that has only been so since it was obvious to all that they were struggling.

Even Hector Sants, the chief executive of the UK’s FSA, told a paper that there was no evidence of unfair market manipulation by short sellers (he also denied getting any calls from the UK Government, somewhat damaging Gordon Brown’s claim to being the instigator of the short selling ban) but that his concern was what might happen in the future. So going short can force prices down in failing companies – so what? Going long forces prices up, but no one is suggesting banning going long because it inflates share prices in unrealistic companies. Remember the dot.com boom? Incidentally, forcing short-sellers to liquidate their position whilst knowing the US government is about to launch a $700 billion bail out is something close to dubious practice itself.

Banning a 400 year-old investment strategy can hardly be called a considered approach to the crisis. Surely the question is one of capital adequacy and confidence. Short sellers only highlighted the weak, they did not create the high-risk banking strategies, the ignorance of stress testing and mitigation processes that created the situation. How about something really radical like real assets must equal real liabilities? Which brings me to Basel II!

Basel II allows banks to mitigate their risk by using insurance. Clause 677 states: "Under the AMA, a bank will be allowed to recognise the risk mitigating impact of insurance in the measures of operational risk used for regulatory minimum capital requirements. The recognition of insurance mitigation will be limited to 20% of the total operational risk capital charge calculated under the AMA.” That is the service that AIG were supplying – but rather than using AIG to reduce risk, banks were using them simply to reduce capital requirements. These banks applying AMA were the big banks. Something for the Basel Committee to reconsider?

Finally, what of the US bail-out, the true reason that shares rebounded? $700 billion, plus around $200 billion to support Fannie and Freddie, plus $85 billion for AIG, plus what else? That is a lot, even for the USA – what will it do to US government stocks and the dollar? How go the models now? Did anyone stress test this scenario?