Shares in Britain’s largest mortgage lender HBOS (HBOS) have been making the news for all the wrong reasons.

US hedge fund Harbinger Capital shorted HBOS stocks, revealing under new disclosure rules that it held a 3.3% short position, worth about 345 million pounds.

Lansdowne Partners and Meditor Capital Management also revealed short positions of less than 1% in the bank, according to a report by Thomson Reuters.

HBOS shares have plunged since it announced a plan to raise £4 billion last month. And yesterday they dropped below the rights issue price.

Of course, as John Stepek points out in his Money Morning newsletter, shorting Britain’s biggest mortgage lender is hardly rocket science, given the overall shape of the British housing market. The real question is who the hell would go long on the likes of HBOS?

You have to laugh really. Though perhaps not if you’re an HBOS shareholder.

The Financial Services Authority has just introduced a rule forcing short-sellers of shares to disclose when they hold short positions of more than 0.25% of the stock of a company undertaking a rights issue (if you’re long, then you have to reveal when you hold 3%).

The FSA’s move was partly in reaction to a sharp plunge in HBOS’s share price back in March. The FSA blamed this on false rumour-mongering and vowed to hunt down the culprits, but the watchdog has been forced to admit defeat.

Meanwhile, its new rule on short disclosure forced Harbinger Capital, headed up by one of the world’s best-paid hedge fund managers, to reveal it was shorting not 0.5%, not 1%, but a whole 3.29% of HBOS stock.

When confronted with evidence that one of the smartest (at least, if you judge investment skill by the size of his pay packet) of their number was betting so extravagantly on Britain’s biggest mortgage lender to fall, all those independent-minded contrarians in the City did exactly what you’d expect.

They sold in droves…

HBoS saw its share price sink beneath the 275p price of its rights issue yesterday, falling 4% to 270.25p. We’ve already written about this (see: Why British property could be China’s next dud investment), but it looks increasingly like the underwriters, Morgan Stanley and Dresdner Kleinwort will have to carry the £4bn can for this one.

There were plenty of good reasons for HBOS to fall. There was the news from Rightmove that even house asking prices are now falling. A hammering for commercial property stocks after a heavy downgrade from HSBC also cast a general pall over the banking sector.

So it isn’t all down to revelations that hedge fund managers are shorting the stock by any manner of means. After all, that’s what hedge funds are supposed to do – generate ‘alpha’ (market-beating returns, basically) by taking advantage of anomalies in the market that no one else has spotted.

And this is the slightly worrying thing. After all, it shouldn’t have taken a genius to figure out that HBoS is not in a great position at the moment. Sure, March’s sharp sell-off had a whiff of rumour-inspired panic about it, but in the rather fevered post-Northern Rock atmosphere, it wouldn’t have taken much to inspire a run on bank share prices. More to the point, the stock has fallen by nearly 40% since then.

The real wonder is that anyone is long on HBOS, not that some highly-paid ‘experts’ are shorting it. After all, this is Britain’s biggest mortgage lender we’re talking about here. It has a great big loan book secured against what is the single most vulnerable asset class in Britain right now – residential property.

Now that wouldn’t be such a big deal if you thought that the management team has been prepared for a downturn, After all, all good things come to an end, don’t they? Yet it seems that they believed their own hype. Even now, after several downward revisions, they’re arguing that house prices will end the year down just 9%, which is frankly optimistic by most counts these days.

But there’s no point in the HBOS board just keeping their fingers crossed and hoping things will get better, because they won’t. HM Revenue & Customs data released yesterday showed that the number of property sales (both commercial and residential) has fallen by nearly 40% in the past year. There were 100,000 transactions in May, compared to 158,000 the year before.

Just how low can prices go? The latest participants at our property RoundTable had a wide range of predictions, spanning a range from ‘gloomy’ to ‘positively catastrophic’.

Suffice to say, the property market’s going to get a lot worse before it gets better. And that pretty much means the same for the outlook for HBOS. Even if the share price does manage to claw its way back up above 275p, I wouldn’t be taking up the rights on this one.

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