The cost of shorting isn’t back to pre-crisis levels, but it’s close. The net cost for prime brokers to borrow stocks in the Standard & Poor’s 500 index was, as of mid-September, almost nothing. That puts lending costs back to their pre-crisis level in January 2008, according to S&P, which recently unveiled a series of indices tracking the cost of securities lending.
Low demand and high supply are both keeping prices low. Pension funds and other clients of custodian banks—the big holders of securities—suffered losses in 2008 and would rather continue lending stock to prime brokers, even at less profitable rates, than have to give back the margin cash. Short interest in U.S. equities on loan totaled $250 billion as of June, down from a peak of nearly $400 billion in 2007, S&P says.
The new indices, launched September 14 (but including data going back to May 2006) show the cost for prime brokers to borrow is actually a bit cheaper than between 2006 and pre-crisis 2008, as measured by the spread between fees and the interest earned on cash (see chart below).
The fee/interest spread shows that lending costs hit peaks in 2008 when the SEC banned short selling on September 16, when Congress rejected the first bailout bill on September 30 and when the Federal Reserve reduced its target funds rate to 1.5% on October 8.
The absolute levels of fees and interest are another matter, having both substantially declined from their crisis levels, as the cost of capital has dropped to almost nothing while custodians have lowered fees.
S&P is planning to license to banks the right to offer securities linked to its lending indices. That would allow end borrowers, such as hedge funds, to hedge their exposure to borrowing costs, which would have saved hedge funds a lot last year.
--Josh Friedlander
