HBoS: It was the Market (Structure)

Sure, sure, 'The Crisis' is over, right? Even the once-venerable American investment bank, Goldman Sachs, went so far as to suggest that bruised Scottish banks probably don't need a capital top-up, despite that it only seems like yesterday when some other Scotsmen were heard yelling animatedly "Captain, Ahh doon't think ahhh kin keep 'er together much longer..." (See left), and he wasn't talking about the USS Enterprise. Dilithium capital is apparently as precious and scarce as dilithium crystals. Yet despite the subsidence of the market's worst fears, and the blassing of the annointed ones, HBoS will attempt to tap the market for 8 billion more. "Ahh nid moore power, Cap'n..." was never more apt.

Last week, Ultimi Barborum waxed critically about a recent academic examination of short-selling, lambasting the doctoral candidates for their uvenile and naive understanding of the practicalities of plunging. But it wasn't just the academics who believe dark, perhaps collusive, forces move markets to the downside as even writers closer to the trenches at FT Alphaville mocked the FSA's quick defense of hedge funds in the HBoS 'bear-raid' accusations. They also snidely dismissed the AIMA's hair-trigger absolving of the Hedge Fund Industry as a whole. The FTs cynicism is, if nothing else, likely to be statistically correct even before one examines whether their claims are defensible, if only because both have proven themselves as objective as Radio Pyongyang in their role as what are effectively trade associations. Here, I will admit that I am viscerally sympathetic to the FTs view, despite its cynical simplicity.

But, imagining for a moment IF the Hedgies didn't do it (a possibility, despite their detractors, both public and private), the question remains who and what conspired to decimate the share price of HBoS? For sure as rain is wet, we didn't imagine the what-for-the-moment I will call "happenstance", that almost left The Taxpayers of Great Britain long of their second major financial institution, and prompted the Bank of England to flash equity traders a "yellow card", even if the "red" one was firmly put away in a locked cupboard, off-site. Apologists, will say it was simply "the market", coincident with extreme fear and pessimism that had already seen two large and prominent contrarian investors (SRM & RAB) impaled upon Northern Wreck, along with another gored by the Bear. Fair enough. But this too, is rather simplistic and sheds little light upon the mechanism of negatively cascading prices, and whether it combusted spontaneously, or had some help from a not-disinterested arsonist.

Leaving aside this possibility, one thing is clear to me: it is unlikely that in the short time before the FSA said "NOT GUILTY" that the FSA could have even begun to unravel the time&sales data to establish culpability, and they are unlikely to do so for fear of what they might find which could indict those they've already defended, and whose protection they seem to be charged. By comparison, the "Public Interest" is a distant second, unless "the Public Interest" is defined as insuring London remains the financial centre of Europe irrespective of overt or covert chicanery of market participants, contrapreurial activities of their masters, or shameless predatory tax and regulatory behaviour in regards of other EU nations bested only by Liechtenstein and Confederation of Helvetia. I am, of course, making a conjecture that might be "off base", for the sellers might have been bona fide "long only" holders (e.g. L&G, Standard Life etc.) fearful of another large portfolio holding biting the dust. Nonetheless, "Time & Sales" coupled with forensic analysis would have revealed all, and such details should be made public, in aggregate or digested form, at the very least to Elroy Dimson at LBS (or yours truly!) who could study the actual data and report upon them further in an unbiased manner. For if nothing else, it would be good to know whether they were long sales or short sales, and whether they originated from a single large investor, a group of colluding investors, brokers privileged to client order-flow, or, "the market" at large.

In the absence of veritable proof from the FSA or Bank of England, those curious must take a stab at understanding what happened, for simply calling it "the market" leaves one wanting. Here, I am not going to construct a mathematical model (mostly because I am incapable), but I am going to ask ruminate upon the market structure and the transmission mechanism and take a stab at deconstructing the chain of events. In the beginning, the HBoS was vulnerable. The decimation of anything mortgage-related in the US was nearly complete, but the UK banks were - excepting Northern Rock - still standing despite over-reliance upon the capital markets for current funding, lax lending standards and massive run-ups in capital values that should make any risk-manager wonder whether even a 20% initial margin is sufficient when you will have no chance in the future to ask for variation margin. That said with sentiment poor, someone thought it grand to sell some. Here is doesn't matter whether its a long or a short. The market buys the stock, marks it down, looking for a turn. Micro-structure traders sniffing for the flow smell the persistent offer and bid-side trade, and sell more. The market (liquidity providers) now long of stock look for buyers away. None to be found. Some big-swinging-three-letter-dick Hedge Fund, hearing the desperation in the voice of the sales trader, turns around and abuses this information to shoot some large borrowed lines of stock, wholly on spec, onto the market (though not executing through the one who called them to show them stock, for this would at once be both impolite and bad form). Three-letter HF manager calls some "friends" (acquaintances more appropriately) to tell them of the call he received from the unfortunate sales-trader, for he hopes to induce them to short some in aid of his new position. HFM#2 checks his book, sees a small long, blows it out, and sells some short for good measure. Market-makers and quantitative liquidity providers turn around and puke their accumulated position(s), back away bids from the market, and sell some more short for their own book. CTAs witnessing a real-time medium term Donchian Channel breakdown mimetically initiate new shorts on top of the old shorts initiated in short-frame horizons. Further stops are triggered. Options market makers too are short gamma on the put-side, must sell additional stock to to re-hedge. Now, external folk are looking for "a reason". Rumours fly, for people, i.e. salesmen and traders want to appear informed. And its pretty easy to conjure one. Heck I can conjure five highly plausible ones without any effort whatsoever, so imagine what a sales-trader or actual trader of UK stocks could do with a concerted motive! Bank analysts start fielding phone calls from ostensibly long-term portfolio managers. PM teams meet and discuss the falling price and its similarities to Northern Wreck, and in response decide to pare their positions. More stops (bigger and longer term) are triggered all around. Now Chief Investment Officers are on the Phone to The Bank's CEO and Chairman (who are at The Club) demanding explanation. Explanation of what?. Of WHAT??!?!? The rumours. The RUMOURS damnit! The rumours that you "...can't hold it together fer much longer..."

Tomorrow: Part II: All is forgiven....