Markets and Morality

Short selling, imprudence and the Archbishop of York

Christians have a duty to be properly informed when they speak out. Catholics specifically call the sin of blundering into the unknown “imprudence”. Surely the Archbishop of York was imprudent when he condemned short selling. This is partly because of the language he used. His language both belittled the sins of bank robbers and vilified the behaviour of people who may well just be going about their job honestly: including that of many Christians who work in the City. Also, I wonder if he really understood the practice he was condemning. As this is an economics blog, I should concentrate on that rather than on the theology! So, here goes…

Firstly, there is no evidence whatsoever that short-selling brought down HBOS. If the Archbishop of York has such evidence, he should present it. He will struggle to find any evidence at all, yet that is the very serious accusation he made. All that short selling can do – except in some very limited circumstances – is cause a share price to reflect information quicker than it otherwise would. Who would short sell a stock like HBOS when it was not believed to be fundamentally overvalued? If the market price then rose, a huge loss would be made. Of course, if the short seller rigs the market or spreads rumours to cause the price to collapse so that the shares can be bought back at an artificially low price then that is a different matter. That is already illegal and generally fraudulent. So, short selling improves the efficiency of a market – which benefits everybody. It is possible that short selling in very small companies might bring a company down, even if it were not fundamentally overvalued at the current market price, but we are talking about HBOS here – one of the biggest companies in one of the biggest stock markets in the world.

Secondly, there is no intrinsic difference between the effect of short selling £400m of a stock in which one has no initial holding and deciding to sell £400m of the same stock in which one has a holding of £1bn. Why does the Archbishop think that one is okay and the other not? Both moves would have driven down the price of HBOS. He might argue that it would be a more civilised and ordered world if we only owned assets rather than the complex paper claims and negative claims that make up our financial system today. But it happens to be a convenient, and sometimes cheap, investment strategy for some pension funds to invest in a way that combines funds that get involved in short selling with indexed funds. The net result is the same as that from a fund that only invests long.

Finally, if we take a stock that is (say) 5% of the index, it is possible to be twenty times overweight in that stock (by making it 100% of your portfolio). But the most we can be underweight is the value of the 5% holding (by holding nothing) unless we short sell. Short selling allows a fund manager to express a negative opinion on a stock to the same extent as he can express a positive opinion. This allows information to be more quickly reflected in the price.

Archbishops can condemn immoral, high handed and greedy behaviour, but to condemn a class of people involved in a legitimate activity that is facilitated by the Church of England itself is a serious error. His move has added to the panic, hysteria and suspicion – as if the situation in financial markets is not bad enough already.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

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