Crisis in the banking sector

Following the crisis in the banking sector in the last week, the Irish government has improved the deposit protection scheme.

The scheme now guarantees deposits up to €100,000 and covers deposits held in all banks and credit unions. Prior to this, the scheme only guaranteed 90% of deposits up to a maximum of €20,000 held in a bank account. This scheme is funded by the financial institutions themselves. They must contribute 0.2% of all deposits held to the Financial Regulator.

The Financial Regulator in both Ireland and the UK has also banned the short-selling of banking shares as of midnight on Thursday September 18th.

Short-selling of shares is the practice of selling shares in a company you do not own and hoping that the share price falls so you can buy them at the lower price.  It happens when a speculator borrows shares in a company from another party for a particular period of time and then sells them in the hope of buying shares in the same company again for a cheaper price. The speculator then gives back the shares borrowed and pockets the money made in the intervening trade. It is simply a way of making a profit from a falling share price.

Speculators have targeted bank shares in the past 18 months by betting that their share prices will fall due to the “subprime crisis” in the US and falling profits due to the collapse in the property sector in Ireland and the UK. This strategy has proven to be extremely profitable. Northern Rock and AIG have been nationalised. HBOS had to be taken over by Lloyds TSB. Bear Stearns was taken over by JP Morgan, Lehman Brothers has gone bankrupt and Bank of America took over Merrill Lynch.

Some speculators have made enormous profits from short-selling banking shares in the last year. Here are a few examples:

Crispin Odey

Mr Odey and his wife Nichola Pease have been dubbed the “Posh and Becks” of the investment management industry. While Ms Pease works for the more traditional JO Hambro, Mr Odey, a former portfolio manager of Barings, runs his own hedge fund Odey Asset Management. The group, set up in 1991, made a profit of £55.3m (€70m) in the financial year to April, and he earned an eye-watering £28m (€35m) himself. Much of his success has come from his bearish stance on financial stocks and his prediction of the credit crunch. This has bolstered his fortune to more than £300m, (€375m) according to The Sunday Times Rich List.

Paul Ruddock and Steven Heinz

Paul Ruddock, a former Goldman Sachs banker, and Steven Heinz set up Lansdowne in 1998, and a decade on The Sunday Times Rich List puts their fortunes at £350m (€440m) each. Lansdowne is one of the biggest UK-based hedge funds and is a serious investor, short and long, in the domestic financial services market. It was famous for a long-term short position in Northern Rock, which paid off spectacularly when the bank fell apart – talk was that the trade brought in $200m (€140m) for the group. It also shorted HBOS, holding a 0.58 per cent short position earlier this year. The group manages more than $17bn (€12bn).

Philip Falcone

The American former head of trading at Barclays Capital is reputed to have earned £865m (€1bn) following a successful year for the group. This allowed him to spend $49m (€34m) on a 27-room townhouse in New York previously owned by the Penthouse magazine publisher Bob Guccione. He runs Harbinger Capital, the US based fund, which scours the globe looking for distressed investment situations, and earlier this year its focus firmly fell on HBOS. At the time of the UK bank’s rights issue it revealed it was holding 3.29 per cent of the stock on loan, a bet then valued at about £348m (€437m). Harbinger, which manages around $20bn (€14bn), also owns a significant stake in The New York Times and is pursuing the satellite group Inmarsat.

Paul Marshall

The $15bn (€11bn) hedge fund Marshall Wace was established in 1998 by Paul Marshall and Ian Wace. The group became one of the most powerful in the City through a computer programme called Tops built by Mr Wace. It rated analyst’s reports and allowed the managers to invest accordingly. Mr Marshall, formerly of Mercury Asset Management, was a researcher for the former Liberal Democrats leader Charles Kennedy.

Noam Gottesman

The Israeli-American businessmen is chairman and co-chief executive of the company he founded with Pierre Lagrange, a Belgian, in 1995. The group is the largest independent hedge fund manager in Europe, and looks after assets worth $23bn (€16bn). Last year its founders both made an estimated £400m. GLG is a serial UK bank shorter, targeting Bradford & Bingley and Northern Rock.

The most successful short-seller

Source: Irish Independent


2 Responses to “Crisis in the banking sector”

  1. 1 BullMarket1992 September 25, 2008 at 9:23 pm

    Fair-Play to all the short-sellers, if basic business/economics teaches you anything its that you have to be greedy enough to profit when others are fearful,just as warren buffet recently stated.

    Does large-scale short selling harm the share price of a company or general business sector?

  1. 1 This Week « SGC Business Trackback on October 30, 2008 at 6:53 pm

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