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Bear squeeze blues: How to destroy a bank

Set phasers to 'short sell'

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It is thus convenient that the smart quants at the banks can outclass the MSc and often BSc-level agency employees. Ironically the agencies have the harder job, since they are trying to work out the value of an instrument whose real value is often intentionally obscured.

As a reaction to how their performance is perceived the agencies have been hiring some "names", but the actual workers are much the same. To make it more fun, these instruments are traded, which means you want some idea of how likely the firm is to default on a daily basis. But accountancy is not a real time profession, so a lot of traders use models that partly rely on the stock price, since there is an obvious correlation between the expectation of future profits and the chances of it not paying its debts. There are other factors in the model of course - each firm has a sensitivity to interest rates, energy prices, exchange rates, and of course the general economic conditions.

So the ideal victim for this hypothetical operation is a firm that needs to borrow regularly in the short term markets, and has not been hurt too badly by current conditions. You don't want your target to be too feeble, because naturally the stock price will already reflect that. Thus the fact that HBOS was actually run relatively well seems to have helped it become a target.

How to plot a shareprice collapse

As a headhunter I get to hear a lot of things, such as the impending collapse of Goldman Sachs, which I know to be true because I hear it so often - on average every couple of months for the last 15 years. So one gets used to this sort of nonsense, and I guess I'm seen as a good person to feed this gossip to, since I might spread it around. So to get past the normal scepticism, one has to have a good story, and the credit crunch makes for a suitably dramatic backdrop.

Although there is no requirement to report your short position, it's not possible to do it on a large scale without the market noticing. Normally one tries to avoid being conspicuous, since the more you buy or sell the more the market learns about you, and moves the prices against you. There are people whose main role is to keep this effect to a minimum. A big role of a market is the aggregation of information, and sellers give the information that some people believe the stock is worth less than it appears to be.

It is tempting to believe that a cabal of well-financed operators worked together on HBOS. JP Morgan has a "Control Index" for concentrated short selling, on which they flatly refused to give me details. If I had it, I could tell you it implies how they know to a useful extent who was doing the short selling. I would have read that this index showed a dramatic and sustained increase in short selling in the last year. If I could look at it, I'd have seen something close to doubling during the recent crises, and know that the regulators have this data on their desks. Shame, really - that would have been a good part of this piece.

Given that the bank can be hurt by a stock price slide, if your "story" is believed by enough people you can trigger an avalanche. It's hard for any regulator to stop this. Phones are of course recorded, and banks try to ban the use of mobiles, store email, and restrict use of sites like Gmail and Hotmail where your communications can't be monitored or retrieved.

But of course many sites now have forum, comment and chat facilities, and short of cutting off all web access, chatter simply can't be prevented. Even if it could, then personal phones are not recorded, even if you do get the log of who has called who from the telco. The reality is of course rather low tech - there are a lot of bars where one can meet up, casually drop in gossip and note that the market seems to support your idea. Before long it hits the financial press, and even the BBC, which adds to what you are trying to achieve.

If this was a plot, it was very risky. If your pressure on the price stops too early, you can be caught in a "Bear Squeeze". The stock price acts like a stretched rubber band, and to make it worse, stock has to be bought, which adds to the snapback.

So plotters would have to be very well funded, and have complete confidence that higher management would not lose its nerve. That is a very small set, perhaps too small to exist - or too smart to be spotted. ®

Dominic Connor was an occasionally competent CIO developing trading systems, before he wised up and became a headhunter.

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