Streetwise Professor

May 18, 2010

The German Short Sale Ban: Parachute or Anvil?

Filed under: Commodities,Derivatives,Economics,Financial crisis,Politics — The Professor @ 5:37 pm

Europe is thrashing about like a gaffed fish on a boat deck.  The proof?  In a sure sign of desperation, and an effective confession of impotence, Germany has instituted a broad ban on short selling:

Germany will temporarily ban naked short selling and naked credit-default swaps of euro-area government bonds at midnight after politicians blamed the practice for exacerbating the European debt crisis.

The ban will also apply to naked short selling in shares of 10 banks and insurers that will last until March 31, 2011, German financial regulator BaFin said today in an e-mailed statement. The step was needed because of “exceptional volatility” in euro-area bonds, the regulator said.

The panic is particularly evident in the hurried nature of the ban–it goes into effect almost immediately.  (In fact, it went into effect a few minutes before I posted this.)

And it don’t stop there, folks.  Germany’s ruling coalition is also calling for implementation of a transaction tax.

Germany.  Shooting the messenger with an MG-42.  Fat lot of good it will do them.

Indeed, if anything, these measures will make things worse.  This is true in part for signaling reasons.  Markets can smell desperation, and react to it.  This is a desperate move that signals utter policy bankruptcy, and an unwillingness to grapple with the underlying problems.  If people want to short, it is because they think things are overvalued.  And nothing shouts overvalued like financially strapped governments with deep structural budgetary problems spending time and effort tilting at speculative windmills, rather than tackling these underlying problems.  And if the Germans thought things were under control, why take such measures?  The immediate inference is that the Germans think things must be pretty bad.

These measures will also make things worse because they will impair liquidity, and shift selling pressure into other markets.  Some “naked short” CDS are in fact hedges.  Dirty hedges, but hedges nonetheless: market participants may short a more liquid credit in order to hedge a position in a related, but illiquid credit (perhaps one for which no CDS is traded at all).  But if they’re doing this, it’s because they want to reduce their exposure.  The ban doesn’t make that desire go away.  So, they’re likely to respond by selling off some of the more illiquid cash positions.  Shorting liquid bank stocks can also be a dirty hedge for exposures in less-liquid bank stocks or debt.  Again, the ban will redirect some selling into less liquid instruments.

The transactions tax, if implemented, could be especially pernicious in these conditions.  It will reduce liquidity.  It will also impede the reallocation of risks to those willing to pay the most for them.  This is hardly the way to bolster the financial sector.

All of the measures Europe has adopted, starting with the bailout, to the not-so-sterilized intervention that has cratered the ECB’s credibility, to the short sale ban, fail to come to grips with the underlying solvency problem.  Indeed, they all signal a basic refusal to deal with that–especially the last.

In the initial EUphoria following the announcement of the $1 trillion initiative, I thought that the key indicator of its ultimate success would be the Euro.  And after an initial spike, it has been down.  Down hard.

It is now trading at a 1.21 handle.  It is down 2 cents since about 11:30 CT today (CME futures).  I haven’t been able to confirm the time that the BaFin announcement was released, but I received an email with a story confirming the ban at 1:30 today.  So I suspect that most of the hard selloff in the Euro was a direct response to the announcement.  (Hey, if you can’t short the governments or the banks, might as well short the currency!)

That’s great for those of us planning a European vacation (volcanoes permitting), but it is a very bad omen for Europe.

It ain’t so great for the rest of the world either.  The European chaos, combined with China’s attempts to de-fizz is weighing on commodity prices: oil is down (below $70/bbl on the WTI) and copper is down too, below $3.00/lb.  This does not bode well for growth in the near term.

Look out below.  Especially in the Eurozone.  And no, a short selling ban doesn’t make much of a parachute.  An anvil is more like it.

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  1. Ruh-roh. I’m many years gone from my analysis days but, were I still sitting in front of the greenscale screen, my initial thought would be, “Oh crap! The Germans know something that I don’t…something bad.”

    My second thought would be, “Is the ban only good for the EUrozone?” If it were only valid in EU trading shops you can bet I’d be on the phone to NYC and London shorting the ever-lovin’ crap out of the Euro.

    Which I doubt is what the Germans intend to have happen. It’s been so long since the EU has had a currency slip…do they have people over there who know how to send the right signals to shore up international confidence? Not seeing anything so far…

    Comment by Swaggler — May 18, 2010 @ 9:54 pm

  2. Arguably one of the silliest posts I’ve read in a long time. How does selling naked CDS offer anyone any protection? For a trivial on going (and perhaps up-front premium), a short seller in CDS takes on enormous, unknown risks.

    The German ban, I beleive, actually prohibits purchases of CDS unrelated to hedging. So an investor with a position in sovereign debt is free to purchase CDS on related sovereign debt.

    Comment by barry — May 19, 2010 @ 12:00 am

  3. Barry-
    By holding a naked short you don’t have to report your holdings to BaFin or whoever. Seriously, why can’t you go short just as easily as you can go long? In the end this is all a zero sum game and less participants = less liquidity and + volatility, no way around it.

    Comment by Jack — May 19, 2010 @ 12:13 pm

  4. “Germany. Shooting the messenger with an MG-42. Fat lot of good it will do them.” Ah, German bashing. At least the host has the ‘they’re either at your throat or at your feet’ Churchill quip down pat.

    Comment by Mr. X — May 19, 2010 @ 1:05 pm

  5. Mr. X. If you haven’t noticed, I’m an equal opportunity basher. The US, Russia, the EU generally. Why should the Germans get a pass, especially when they ask for it?

    The ProfessorComment by The Professor — May 19, 2010 @ 7:20 pm

  6. An off the bat idea… Perhaps the Germans want out of the Eurozone. By quitting they will not have to subsidize the Med nations to the tune of hundreds of billions of Euros, and while their banks will suffer from the resulting Southern defaults this should be made up by an influx of capital from the cratering Euro to the new Deutschmark.

    Hence, for Germans… it might now be a question of the worse the better (for themselves). And a reason for indirect sabotage against themselves.

    Comment by Sublime Oblivion — May 20, 2010 @ 3:59 am

  7. Excuse my ignorance but what about that blip in the stock market the other day? Doesn’t it show that it might be perilous to leave things to the markets themselves? After that 1000 point plunge I saw this trader on CNBC desperately asking of the institutions in charge to do something about it, so that they don’t just destroy themselves. How silly it is to have everything hanging on somebody pushing the wrong button ?..

    And what about that mess that was left after ‘prudent’ workings of the markets whereby the whole financial system of the world was put on the brink just by pure greed of those who were supposed to insure that it works properly. Many of these people are simply out of touch, thinking of nothing else but make their buck long at everybody else’s expense.

    Try convince me otherwise after that enormous bomb of barely legal financial instruments that was put under their own butts.
    Leaving that system as it is, swarming with myriads of highly educated crooks, would mean disaster in not such a long future.

    Comment by Rem — May 20, 2010 @ 8:45 am

  8. The financial disaster was primarily caused by the politicians’ corrupt decision to buy votes by providing own housing through Freddy and Fanny to those who have not earned it.

    If you jump in front of a running train, it is not the train’s fault that it runs you over. Somehow the public is able to grasp that if you follow some simple safety rules you can have both trains running and people safe. Yet when it comes to financial markets, all you hear is demands to ban those murderous trains.

    Comment by Ivan — May 23, 2010 @ 5:05 am

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