Jeremy Warner's Outlook: HBOS shareholders forced to pay high price for bank's £4bn rights debacle

As financial bellyflops go, they come none more spectacular than the £4bn HBOS rights issue, which was largely left with the underwriters yesterday.

The fact that HBOS gets its money is some sort of consolation, I suppose, though not to sharehold-ers who now face months, possibly years, of further underperformance as the unwanted rump is trickled back on to the market.

The amounts involved are so large that even the army of short- selling hedgies who descended like vultures on the rights issue process will struggle to mop up the excess as they close off their positions.

How different it looked when HBOS announced the rights issue last April. Back then, many investors couldn't work out why HBOS was raising the new capital. Capital ratios seemed adequate to absorb the losses coming through from the American sub-prime crisis. What's more, with the shares trading at close to 500p, the discount looked so deep as to make the fees being charg- ed by investment bankers to underwrite seem like daylight robbery. Since then, economic prospects have deteriorated sharply, making the extra capital seem not just sensible insurance but a possible lifesaver for HBOS as storm clouds gather.

The share price has also continued to sink, turning a rights issue so deeply discounted that it couldn't possibly fail into yesterday's extraordinary belly flop with a take-up rate of just 8.3 per cent.

In the circumstances, Morgan Stanley and Dresdner did well to place as much of the rump as they did (nearly 30 per cent), yet even with a little extra help from the sub-underwriters, still they are left with 18.6 per cent of the issue apiece. In the past few days, it has emerged that as little as 40 per cent of the issue was sub-under-written with other institutions. Was it greed, or necessity, that caused the lead underwriters to take on so much risk? It is certainly unusual in such a large rights issue to leave yourself as highly exposed as this. Yet like the Titanic, this was meant to be a ship that couldn't sink.

From the sublime to the ridiculous, so desperate was Morgan Stanley to limit its losses that in an effort to hedge its position it had by the end become one of the largest shorters of HBOS stock.

This is not such an uncommon strategy in a rights issue, when underwriters are prone to try and insure themselves against the possibility of a flop through short selling. Yet it shows what an Alice in Wonderland world the financial markets have become that those betting on the rights issue succeeding should also have one foot in the opposing camp of those gambling on it failing.

In any case, HBOS shares are now worth less than half what they were floated for more than 10 years ago and the supposed capital surpluses which instructed the conversion from building society to PLC have gone full circle into a whacking great capital liability.

Meanwhile, Britain's jealously guarded system of pre-emption rights has been tested virtually to destruction. The rights issue method of raising new capital works fine in a bull market, when the mentality is one of onwards and upwards, but has proved wholly unsuited to the short selling moors and rumour mongering of a bear market.

It would be a shame to see the rights issue junked in favour of the American share placement method. You might think that the fees charged for underwriting rights issues are in most cases money for old rope, yet compared with what Wall Street charges for share placements they are small change. The rights issue also protects existing shareholders from the abuse of dilution at discount prices by favoured outside investors.

It may be a bit late now, but the obligations involved in a rights issue must be eased, first and foremost by shortening the process. The nearly three months it took HBOS from announcement to consum-mation is absurdly long. The three separate mailings HBOS undertook to its shareholders – once for the circular, once for the prospectus and once for supplementary information – is also plainly unnecessary in an age of electronic data.

As for HBOS, the concern has switched from whether the bank really needs the £4bn just raised to whether it is enough.