Explain this, econopunks

[ataxi]

"The ban was due to be lifted today and there had been speculation about plans by hedge funds to short sell the shares of the highly market-capitalised big four banks and drive down the value of their stock."
I have a vague understanding of all of the following concepts:

• hedge funds
• market capitalisation
• short selling

I'd be interested to hear someone's

Comments

[zharradan]

I think you have it largely right; the other factor is that the capitalisation of many of those banks *depends* on their share price. Driving it down can create a feedback loop. There's recent precedent for an "attack" like this, because this is exactly what happened to Macquarie a couple of months ago - I believe that at one point their shares were at 50% of their current value, and it was almost solely due to tactical trading.

[strangedave]

They specifically used the phrase market capitalisation -- market capitalisation doesn't so much as depend on share price, but is simply another way of expressing share price (market cap = total value of shares, so number of shares x price). You can't really have a feedback loop with one number.

[anxiolytic]

I'll give it a go.

The Australian banks are vulnerable because of the general ill-will towards banks in general. Apparently ASIC thinks they are so vulnerable to hedge funds (domestic and international) short selling their stock that it has imposed and extended a ban.

Short sellers rent stock (usually from large institutional investors, like super funds) and sell it en masse, with the hope this causes the price to crash. Once it does they buy back the stock (which people have lost confidence in, hopefully for the hedge funds) at a cheap cheap price and give it back to the rentee.

The worry about market cap. is that if the price goes down too low the banks lose quite a bit of power. They can't raise capital through share offerings, take-overs will require more hard cash instead of shares, and they become prime targets for take-overs themselves.

[dunq]

What he said.

It pains me that market manipulation like this is effective. A colleague I spoke to who trades as a hobby says he can "read" a short selling going on and you can use that to your advantage by waiting it out and buying at the low point. It boils down to price signalling, just seeing the number and volume of bid/offers on a stock. Patterns emerge, as they said in PI :-)

If he's doing that then I'd imagine other short sellers would be doing there thing, amplifying the result, to their gain and others' losses.

I am talking out of my arse by the way.

[strangedave]

Why does the highly market-capitalised nature of the big four banks in Australia make their stock prices more vulnerable to short selling?
I think this is as simple as 'if the share price is already high, it is easier for it to go down'. They have a big market cap because their share price is pretty high, very much so (extraordinarily so) compared to foreign equivalents (ie Westpac has, I believe, a bigger market cap than Citigroup right now).

Of course, the Australian banks themselves would argue that the reasons Citigroup etc collapsed so dramatically (they are one of many major institutions that are sitting at less than 5% the market cap they had a year ago) was because they made stupid investments, and the Aussie banks didn't (or no as much), so their market cap is thoroughly deserved, thanks.

[zharradan]

that's pretty funny, I seem to remember that citigroup's loan book is more than 2 trillion dollars but I guess a lot of it is worthless really!

[ataxi]

"if the share price is already high, it is easier for it to go down"

And other truisms. The quote from my post could be rephrased without the needless use of two terms to mean the same thing.

[livelurker]

I found this column pretty good at summing up shorting

http://au.pfinance.yahoo.com/b/marcuspadley/49/the-anatomy-of-shorting/

[ataxi]

Thanks, lurker.