I am reading this article on Prime Brokerages in the Nov issue of EuroMoney. There is a very interesting point on the liquidity available in the shorting market. We know that many hedge funds are stuck in Lehman Brothers UK arm (LBIE) as LBIE lent out the securities further out, and now it is going to be impossible to figure out who owns those securities. There are many owners of the same security.
We have seen several fund companies (State Street etc) curtailing their stock lending programmes. One is the fear whether they ever get the securities back, due to heightened counterparty risks. Two is a stigma attached with helping the shorts. Regulators also keep changing the rules. People are more careful to locate the stock before it can be shorted.
If this is a permanent damage because of the counterparty risk issue, does it mean that several hedge fund strategies like long-short equity or convertible arbitrage become very difficult to implement even when markets stabilize? Because if one can't locate the stock as people are unwilling to lend it out, the shorts can't short it. Thats not good for the long-term market structure.