Brit Market Watchdog Slams Rumors

Following a sell-off of mortgage giant HBOS's stock, the FSA denounced "unfounded" reports of weakness among British financial houses

On Mar. 19 the British market was expected to rally following Wall Street's strong showing. Instead, share prices were hit hard by rumors that HBOS (HBOS.L), the largest British mortgage lender, was seeking emergency funding. The bank has categorically denied that it is in trouble. Still, its shares fell by as much as 18% before recovering. Shares of other banks such as Royal Bank of Scotland (RBS) also fell, before recovering in turn.

Such volatile swings in bank shares have caught the attention of regulators. The Financial Services Authority, Britain's all-purpose market watchdog, said on Mar. 19 that it is investigating trading in British financial shares in recent days. In a toughly worded statement Sally Dewar, managing director for wholesale and institutional markets, said, "There has been a series of completely unfounded rumors about British financial institutions in the London market over the last few days, sometimes accompanied by short-selling. We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumors and dealing on the back of them."

To short a stock and then spread rumors about it is considered "market abuse" in Britain and could lead to fines, bans from the securities industry, or even jail, according to an FSA spokesman, Joseph Eyre. British regulators regularly scan the transactions of hedge funds, investment bank proprietary trading desks, and other big traders. With markets in turmoil, they are stepping up their activities, particularly with regard to banks.

Heading for Lean Times?

How easy it will be to track down the rumor-mongers remains to be seen. For instance, market participants say the HBOS rumors probably filtered over from the U.S. overnight. Stock trading is a global activity, and banks are among the most closely watched and volatile stocks these days, following the Bear Stearns (BSC) collapse. Traders are trying to identify the next institution that will disclose big losses or, even, suffer a mortal wound.

It doesn't help that analysts think Britain's banking sector, which has been a huge moneymaker during the recent fat years, is heading for lean times (, 2/21/08) in the new, much harsher credit environment. Already banks' funding-costs have risen while commercial property values have fallen, leading to what is likely to be a profit squeeze in the coming two years or more. Bear Stearns in the U.S. and Northern Rock (NRK.L) in Britain have shown what can happen if counterparties and the wholesale markets lose faith in banks' creditworthiness (, 3/17/08)—a risk that is certainly in the air at the moment.

However, there do not seem to be any dire issues involving HBOS at this time. Michael Helsby, an analyst at Morgan Stanley (MS) in London, says the market concerns about HBOS were "massively overblown." He says the bank has raised $9 billion in new debt since the start of the year. But until the markets calm down—which could be a long time from now—banks could very well find themselves under sudden attack.

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