Yes to Lloyds-HBOS 'Superbank', No to Short Sellers

The Telegraph called it a the triumph of the hare over the tortoise. Risk-averse Lloyds TSB looks set to take over HBOS to form what's been called a £30bn 'superbank' -- with 28 per cent of the UK mortgage market and links to 40 per cent of UK homes.

The £12.2bn merger been widely termed a 'rescue', but is that fair to HBOS? Scotland's First Minister criticised the deal as a "shotgun wedding" prompted by "short-selling spivs and speculators".

It's not the first time HBOS has been targeted. Earlier in the year, the bank's exposure to sub-prime loans laid it open to false rumours by short-sellers (who borrow stock from an investor, sell it on the relevant market, hoping to buy it back for less and pocket the difference.) Hedge funds are generally blamed for shorting a company's position.

Prime Minister Gordon Brown, whose government waived competition rules to ensure the deal went ahead, criticised the irresponsible behaviour of unscrupulous short-sellers and vowed to "clean up the financial system".

So it's not surprising that the FSA has now banned short selling of financial stock in the UK. In a statement, FSA chief executive Hector Sants said the regulator still regarded short selling as "a legitimate investment technique in normal conditions" but that current "disorderly markets" warranted a ban. It will also demand daily disclosure of net short positions over .25 per cent of a company's share capital. These rules will stay in place until January 2009, but will be reviewed in 30 days' time, and may extend beyond financial stocks if it's deemed necessary.

It represents a battle lost for the Alternative Investment Management Association, the hedge fund industry body, whose chief executive, Florence Lombard, blames "a widespread lack of confidence by all investors in financial markets" and "excessive lending practices by banks" and over-valued property prices as the real villains. The AIMA argues that a ban will slow down the market while simultaneously allowing the fallacy of over-priced stock to persist.

The FSA's response is inevitable, and necessary -- once the financial market fears started spreading beyond the Square Mile and threatening to panic the general population, it became a political issue. But any attempts to rush through further regulations would be a mistake.

The mere fact that government's allowed the HBOS Lloyds TSB deal to take place is already disruptive enough. Whether it's a good idea remains to be seen -- job losses across the group are a given, with speculation that as many as 40,000 jobs could be axed. "In this case, financial stability must trump competition," said Chancellor Alistair Darling.

In the short-term, he's right. But behind it all remains the question of how HBOS found itself in victim position this week. And behind the short-seller question is another, very salient one put by one Doug Brodie to Money Marketing: Why do pension funds, fund managers and insurers lend stock to short-sellers in the first place? As editor John Lappin observes:

"Lending your Porsche to your brother-in-law with a risk however small of seeing it returned on the back of an AA truck. That is far too trite. But it is hugely more serious than that. These institutions take investors' money for a pension and then they lend it out where there is a risk its share price can be damaged."