Markets rocket as US prepares monster rescue

The FTSE is up almost 400 points as the Fed prepares the mother of all bail-outs. Is this really good news?

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Last Updated: 31 Aug 2010

If it closes at that level it wil be the FTSE's biggest ever one-day rise. Other markets around the world are responding in similar fashion. The Federal Reserve's plan – apparently centring on the creation of a state-owned ‘bad bank’ to nationalise the worthless ‘assets’ currently poisoning the system – sounds breathtakingly ambitious and will require a superhuman legislative effort given that there are not many sitting days left before the US elections begin. It could, says the rumour mill, cost as much as a trillion dollars, dwarfing any other market intervention that has gone before it.

Of course it is superficially a big relief to see the world’s indices turn green again after a week in which red screens have been the backdrop to so much chaos. The psychological effect alone should help to calm the febrile markets.

But is it really such good news? Given that the Fed’s grand plan is still far from being in place – in fact it hasn’t even been properly announced - today’s huge market upticks on both sides of the Atlantic look no more rational than were Monday and Tuesday’s catastrophic falls. The whole situation continues to raise some fundamental and extremely uncomfortable questions about the financial system we have created and the people who are in charge of it, both regulators and regulated.

The other big story of course is the joint effort by the US SEC and our own FSA to clamp down on short-selling. Anyone with a short position of more than 0.25% in any given stock has until Tuesday to declare it or face the wrath of Hector Sants and Christopher Cox. HBOS shares are up 50% today, doubtless partly as a result of a lot of panicked hedge-funders seeking to close their short positions ahead of the deadline. Perhaps if the ban had been imposed earlier this week, the whole Lloyd’sTSB rescue might not have been required in the first place. Surely it would have been worth a try at any rate. But of course, the City always loves a big deal, and the big money that goes with it.

Now we know that short-selling has its place in the normal trading regime - despite the fact that to those not versed in the City’s flexible brand of ethics, selling something that doesn’t belong to you seems just plain wrong. But even Saint Warren of Omaha thinks it is worthwhile as a corrective for over-valued stock and to improve the efficiency of the market, and no fan of fancy financial footwork he.

But this temporary ban is in the current circumstances a good thing, and not only because it might bring some of those irredeemably smug hedge fund types down a peg or two. It’s a question of balance - as the events of this week clearly demonstrate, when the majority of trading in any given stock is short-selling then the share price will enter a vicious circle - a positive feedback loop - which result in its collapse at an artificially accelerated rate.

Those who claim that shorting simply hastens the inevitable are missing the crucial point that the speed of events can make an unhappy ending that was far from being inevitable very much more likely. Even a fundamentally sound business can find it impossible to cope with losing half its market value in a couple of days, as HBOS’s Andy Hornby found out earlier this week. 

So, some good news at the end of a pretty torrid few days. But we’re not out of the woods yet – if the Fed deal proves one thing, it’s that the authorities think there’s still a whole lot more crap to come out of the system. And it’ll be taxpayers all over the world who end up footing the bill.

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