Stocks that are frequently sold short are labeled as "hard to borrow." Legally, in order to short a stock, it is necessary first to borrow it. When there is too much demand, the stock becomes hard to borrow.

A frequent result is so-called "buy ins," mostly at the end of the day. Those who have made naked short sales must locate stock to borrow or buy the shares to deliver. The result, prices run up rapidly for a half hour or so, then fall back to where they were before. It's like a mini short squeeze, and short-sellers regard it as a cost of doing business.

I have been buying John Hancock Bank and Thrift Opportunity (BTO), a mutual fund that specializes in banks, mostly regional, and thrifts, with the idea of letting someone else do the stock picking but playing for a bottom in bank stocks, if there is one. So Thursday last week I went to buy a few more shares and my brokerage software informed me my BTO is "hard to borrow."

I was a little surprised - the fund now trades at an 18.8% discount to NAV, so my thinking has been that I have 12 or 13% built in when the discount gets back to a more normal level, as well as the expected recovery in the prices of the bank stocks in the fund's portfolio. I couldn't fully grasp why anyone would want to borrow a fund that trades at a large discount to NAV, in order to sell the whole for less than the sum of the parts. I guess it's simple, they have been making money doing it, or otherwise they would give it up.

I asked my brokerage rep to comment, he didn't have much to add, yup, theyr'e doing it. Looking at BTO's holdings, they had some names I have heard of and some names I'm not familiar with - but there were an awful lot of them and I would assume they put some thought into the selection.

This is less upsetting than for example when short-sellers attack an individual stock that may be subject to rating agency downgrades based on nothing more than the share price, with triggers activating collateral calls and destroying credit and tipping over the apple cart on some derivatives somewhere. It's not possible for short-sellers to do any permanent damage to a mutual fund. All they can do is drive the price down lower, increase the discount to NAV.

To me, this is a symptom of a negative bubble - a short-seller by definition is selling this fund for about 12% less than it is worth, based solely on the belief that the downward march of doom must continue indefinitely. Eventually it will end as all bubbles do, suddenly, and with pain for the greatest fools.

Comments: View Comments |  Saturday March 7, 2009  |  Stocks: BTO,