Comment: Gerard Baker | Comment: Leading article | Comment: Camilla Cavendish | The speculators who made millions

Speculators and hedge funds have been banned from betting on British banks going bust in a dramatic move by the City’s regulator.

The Financial Services Authority hopes that the temporary crackdown will prevent the downward spirals of bank share prices, reduce the likelihood of another Northern Rock-style run and encourage banks to start lending again on better terms.

The news came as Gordon Brown pledged to clean up the financial system after the rescue of Britain’s biggest mortgage lender, HBOS, by Lloyds TSB. The Prime Minister called for action through the regulators to require banks and other institutions to declare their off-balance-sheet liabilities, which could run into $1 trillion worldwide. It comes after suggestions that some bank chairmen do not know their full exposure.

In a concerted effort to calm the financial markets, regulators in America began to investigate possible illegal short-selling of shares in Goldman Sachs and Morgan Stanley – both still struggling for survival – and said that they would investigate the collapse of Lehman Brothers.

Central banks, including the Bank of England, made an unprecedented joint effort to pump $180 billion into worldwide financial markets to prop up cash-starved banks and allow them some breathing space.

Short-selling is where traders can profit from betting that a share price will fall. The practice is not illegal, but it is a criminal offence to profit by spreading false rumours to drive down a company’s shares deliberately. Regulators on both sides of the Atlantic are concerned that malicious short-selling could topple a weakened bank into a catastrophic failure.

The US authorities said that opportunistic traders must disclose how many shares they held in companies, but stopped short of banning short-selling, instead promising to root out and prosecute the risky traders.

Shares in Morgan Stanley, one of Wall Street’s most powerful investment banks, fell by a further 23 per cent on fears that it would be the next victim of the credit crisis. Sources said that China Investment Corporation, which has a 9.9 per cent stake in Morgan Stanley, was in talks to raise its holding to as much as 49 per cent to prevent a Lehman-style collapse. Goldman Sachs shares were down 13 per cent in a second day of heavy selling.

The FSA’s surprise announcement, banning the short-selling of shares in all financial companies from midnight last night until January 16, was made by its chief executive, Hector Sants.

He said: “While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets. We have taken this decisive action . . . to protect the fundamental integrity and quality of markets and to guard against further instability of the financial sector.”

Alex Salmond, Scotland’s First Minister, criticised the timing of the ban, saying that if the FSA had acted sooner HBOS would still be an independent bank.

In a series of interviews Mr Brown said that he had taken quick action to maintain the stability of the financial system.

The financial crisis, and his suitability to tackle it, will become a central part of his fightback at Labour’s conference next week. The Times has been told that measures either close to implementation or being considered will be given added urgency as a result of this week’s events. They include:

— Requiring banks in trouble to disclose their debts to the FSA, the Bank of England and the Treasury;

— New powers for the Bank to intervene and take over failing institutions;

— Moves to encourage “whistle-blow-ers” about market abuses such as the spreading of false rumours;

— The FSA will give more weight in future regulation to the liquidity of banks. Hitherto they have concentrated on whether or not a bank is solvent;

— More action to tackle short-selling.

— Greater cooperation and information swapping between the various international regulators to curb abuse;

— The establishment of an international early-warning system to ensure credit crunches are identified before the effects spread;

Governments are also discussing proposals under which the financial sector’s troubled assets would be taken over by the public sector. It is the revival of the Greenspan resolution trust fund, an idea put forward by the former chairman of the Federal Reserve in the 1980s.

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