Some commentators on the surprising and not terribly well received unilateral move by Germany to ban naked credit default swaps on sovereign debt and shorting of bank stocks assumed it was intended to placate domestic voters. Merkel’s move to join the Eurozone rescue effort was wildly unpopular at home; taking a tough line with speculators looks like a desperate gesture to restore a semblance of cred.
And indeed, Wolfgang Schäuble, Germany’s finance minister, offered a credible-sounding defense in an interview in the Financial Times….if you were living on Mars and hadn’t witnessed the market’s raspberry:
He wants urgently to rewrite the rulebook of the eurozone to prevent any such crisis happening again, and at the same time to revive the momentum of international negotiations on tougher regulation of financial markets. He has returned to the idea of an international financial transaction tax, to make financial institutions share in the costs of the crisis, even if it can be agreed only inside the European Union….
“I’m convinced the markets are really out of control. That is why we need really effective regulation, in the sense of creating a properly functioning market mechanism.”….
“A market does not function properly if the risks and rewards are completely unbalanced,” he says. “We need transparency. Given the complexity of modern technology, the individual needs a chance to judge what he is doing. That’s why we need standardisation of products. And we need transparency for all market participants.
“We must regulate over-the-counter transactions, and we must also focus on the ratio of financial transactions to the real exchange of goods and services. They bear no relationship to each other. I understand that we need new financial instruments to cope with the huge financial tasks that we face. But, forgive my saying so, minimum profits of 25 per cent are simply unimaginable in the real economy. It isn’t healthy.”
Yves here. These are all sound objectives. Unfortunately, the unexpected move of unilaterally banning certain types of shorts does not appear central to these bigger aims, and may have served to undercut progress towards Schauble’s goals.
But the “what you see is what you get” assessment seems more plausible, that the Germans are worried about speculators….because they legitimately feel vulnerable. The US and UK also implemented bans on short selling financial stocks during the financial crisis. Now these bans are ham handed and appear to be not terribly effective (but the inability to run experiments in parallel universes makes it difficult to reach definitive conclusions).
Now why do the Germans in particular feel a tad nervous? Well, Germany, like the UK and Switzerland, has a banking system so large relative to its economy that it cannot credibly backstop it if it goes seriously off the rails. The problem is more acute in Germany because it does not control its own currency (as it cannot simply throw whatever it takes at the banks and if need be, “print” later; by contrast, the risk to the UK and Swiss banking system comes from its banks’ foreign currency exposures).
Bloomberg gives tonight’s sighting of rising nervousness in interbank markets:
The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, widened to 25.3 basis points from 24.8 basis points yesterday, the biggest gap since Aug. 13. A basis point is 0.01 percentage point.
Short-term funding costs are a “good measure” of the concern in markets that Europe’s debt crisis might spread, [Jeff] Rosenberg [of Bank of America Merrill] said.
“Libor-OIS spreads are on the rise again and that tells you the systemic risk of a restructuring, as the outcome for the European sovereign credit crisis, has not been alleviated,” he said.
Yves here. German banks, particularly the clueless Landesbanken, were major stufees for toxic US mortgage paper. Eurobanks in general are behind US banks in cleaning up their balance sheets (yes, Virginia, we are not number one in extend and pretend). Ambrose Evans-Pritchard argues that the German banks are behind their EU peers (hat tip reader Swedish Lex):
A year ago, Germany’s financial regulator BaFin warned that the toxic debts of the country’s banks would blow up “like a grenade” once hidden losses from the credit crisis caught up with them.
An internal memo at the time showed that BaFin feared write-offs might top €800bn (£688bn), twice the reserves of Germany’s financial institutions. Nobody paid much attention. But the regulator’s shock move on Tuesday night to stop short trading on banks, insurers, eurozone bonds – as well as a ban credit default swaps (CDS) on sovereign debt – has left markets wondering whether the slow fuse on Germany’s banking system has finally detonated….
German lenders have the lowest risk-weighted capital ratios in the world after Japan. They were slow to rebuild safety cushions after the sub-prime crisis, and now face a second set of losses on Club Med holdings. Reporting rules have let Landesbanken delay write-downs, turning them into Europe’s “zombie” banks….
The short ban set off instant capital flight to Switzerland. BNP Paribas said €9.5bn flowed into Swiss franc deposits in a matter of hours on Wednesday morning.
The Swiss central bank intervened to hold down the franc. This caused the euro to shoot back up against the US dollar after an early plunge. The euro had already bounced off “make-or-break” technical support at $1.2135, the 50pc “retracement” of its entire rise since 2000, but any rally is likely to be short-lived.
Yves here. We are still getting some remarkable whisting in the dark from other analysts. From a different Bloomberg story:
“The euro depreciation is very good news for the region” because the rest of the world economy is expanding, said Charles Wyplosz, head of the International Center for Monetary and Banking Studies in Geneva. “This is going to bring a welcome boost that may save the euro zone from outright recession.”
Yves here. Um, the more accurate characterization is that Europe has committed itself to a deflationary course of action and currency depreciation will serve to export it. With US growth less than robust, and China in a tough spot (its expansion is dependent on increasingly ineffective borrowing), the global
“growth” story is fragile.
And if the European financial system starts wobbling, all bets are off. More cheery information from Evans-Pritchard:
Tim Congdon from International Monetary Research said deposit data from the ECB shows that there was a “major run” on Club Med banks in the second week of May. Some €56bn of interbank lending facilities were withdrawn, probably as citizens in the South switched funds to banks in the eurozone core. Bank reliance on the ECB lending window jumped by €103bn – or 22pc – in a week.
“It was extreme and very sudden, probably on Friday afternoon. The eurozone was undoubtedly in peril,” he said.
Yves here. The bailout plan shifted risk from the periphery to the core of Europe, and the core, upon examination, does not look too solid. Prepare yourself for a rough ride.
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‘…taking a tough line with speculators looks like a desperate gesture to restore a semblance of cred.’
Or cling to power – after all, Merkel represents the free market, friendly to ‘Finazinvestoren’ part of the German political landscape.
Wait until you get a chance to see what a (still potential, with many practical hurdles to surmount) coalition of the real socialist SPD, the no longer so utterly radical (in Germany, at least) Greens, and the no longer real communist (according to them) Linke. None of those parties give a rat’s ass about what Wall Street thinks, and the Greens, at least, would love to kill the idea of growth at all costs (how is the Gulf looking these days?) with a wooden stake through its foul heart.
As for the FDP, the closest thing to an American understandable party representing financial/commercial interests – they lost, very big, in the ‘local’ NRW election, in much the same manner that the Linke won. A local election which just happened to mean that Merkel lost her majority in the Bundesrat, meaning that if she wants to get any (well, technically, most) legislation passed, she needs to get along with those states where the SPD, Greens, and Linke hold sway.
Right or wrong (and boy, do they have experience with wrong), the Germans have pretty much decided to no longer play along with Wall Street, the City, Zürich, etc. The results should be fascinating – personally, when the Masters of the Universe start boycotting Mercedes, Porsche, and BMW, we will know that the game is getting serious.
Helicopter Jean-Claude?
German financial regulator Bafin already banned naked short selling last year:
http://www.bafin.de/cln_161/nn_721140/SharedDocs/Mitteilungen/EN/2008/pm__080919__leerv__en.html
In March Bafin issued a notification decree on some short selling positions
“to take targeted action as required, sufficiently in advance and swiftly, against short-selling transactions that pose risks to the orderly conduct of securities trading and the stability of the financial system.”:
http://www.bafin.de/cln_161/nn_721140/SharedDocs/Mitteilungen/EN/2010/pm__100304__leerverk__transparenz__en.html
So hardly unexpected
After a while it becomes a Gordian Knot. The temptation of an easy solution overwhelms the frustrations of complex ineffectiveness.
I wondered if Merkel is contemplating a German version of Maiden Lane. If she forsees an inevitable AIG type bailout of German banks Sovereign/CDS basis books, this move could reduce that risk, or force the disclosure of the extant risk on the books of the German banks.
The idea may be a bit too tin-hat, but the sov CDS blowup smells an awful lot like the subprime CDS crumble.
Naked shorting is illegal in the US.
It was not enforced by regulators who were willing to turn a blind eye to blatant market manipulation.
Germany banned NAKED short selling, not just ‘certain types of short selling.’
This surprise to me just indicates how low our standards have fallen, and how given over to Stockholm syndrome so many are to the speculators and the banks.
I found it interesting that the heavy selling today in US equities, triggered by large trances of SP futures selling near the open, in addition to news indicating the recovery is not gaining traction, was tied by traders this morning over ‘unease the the Congress has not yet killed Blanche Lincoln’s amendment.’
I would that Obama had half the courage of Merkel. And that commentators would pull back from the status quo and realize the sorry state that their economy is in, held hostage by a bunch of spoiled brats and thugs.
Amen.
Excellent post!! thanks and a link to a interesting article on this subject.
http://dharmajoint.blogspot.com/2010/05/merkel-does-mahathir-and-martin-luther.html
Agreed here as well. The thinking here in Europe is that Merkel is setting up to deny bailouts to eurozone banks for losses on naked CDS (rather than expecting an immediate market effect) and that any resulting effect is the bankers and hedgers realizing that a line has been drawn by one of the last players with a credible checkbook.
Thanks for this and the related insightful posts on your blog.
Latest rumors around here have it that Greece wants out of the EU. Apparently there’s a standing invitation to join the AU, with which Greece apparently has a lot in common with (including “we’re a proud bation” bit).
Vinny
PS – in case you didn’t know, AU stands for African Union…
It’s important not to conflate a (thus far) temporary and limited naked shorting ban (the actual German policy move) with straight shorting, which is still allowed. Bankers are pushing this straw man argument and many media reports are buying it without making the distinction. It’s all very hypocritical – in the depths of the financial crisis, Wall Street demanded and received from the SEC bans not only on naked shorting of their stock, but also bans on straight shorting.
Naked shorting is not illegal, but it ought to be. Reg Sho in the US restricts it, but did not eliminate it (there remains significant uncertainty as to how much of this activity moved out of the DTCC system to the ex-clearing system as Reg Sho was tightened).
In any case, even in the US, Reg Sho applies to stocks. Germany’s move was unique and surprising because it applies to some sovereign bonds, an area where naked shorting is prevalent (and even a qualifier for sovereign bonds to be included in certain government bond indexes; eg. South Koea recently allowed naked shorting of its government bonds so that it could be included in Citi’s world government bond index).
The only reason I have seen proffered by bankers as to why naked shorting in government bonds (or any other bonds or stocks) should be allowed is that it creates liquidity. That seems a poor counterweight to what is akin to counterfeiting.
Granted, the manner in which the German’s moved forward was ham-handed. The policy needs to be considered carefully, as it is not a straight line from banning naked shorting on stocks and bonds to applying the same to CDS and similar (do you then ban put option buying if not holding the underlying as well?).
I bet the percentage of Europeans with bank accounts outside their home country is much higher that the percentage of Americans or Canadians with foreign bank accounts. Is that data available anywhere?
NY Times
http://economix.blogs.nytimes.com/
May 20, 2010, 6:00 AM
Irish Miracle — or Mirage?
By Peter Boone and Simon Johnson
Or, why Euro-zone austerity is doomed.
It is unfortunate that Yves Smith is beginning to sound breathless if not hysterical! This is Wall Street thuggery and they are trying to hamstring the little bit of regulation contained in the “Financial Services” bill in the Senate. With what right, does anyone not holding Euro assets have to “short” sovereign European bonds? All moronic, unnecessary speculation. We need to reduce the size of the financial sector that has grown since Reagan’s deregulation kick, “get the government off people’s back”, the idiot’s baloney, just like George Bush’s nonsense.
Chancellor Merkel has done what was needed, and forget about “exporting deflation”. I wish that the current U.S. administration had the same sense/courage. The same thing with “Single Payer.” There is far too much speculation in the stock and commodity markets. Why has the price of oil declined about $20/barrel in the last few weeks? Has oil consumption declined by 25% in the last few weeks? Of course not. At the same time, the price of gasoline is stuck at ~$2.90/gallon around where I live. You think the oil companies with their computers don’t know that consumption has remained unchanged, if not declined somewhat? So, why is the price of gasoline sticky? We live in the age of Monopoly Capitalism and their servants, the Congress and the Supreme Court, are there to do their bidding, that is to say, obstruct all sensible change in the name of “free markets” and anti-“socialism.”It is unfortunate that unregulated, unfettered Britain lacking any manufacturing capability is their accomplice.
After some time, these markets will return to their senses and look for real organic growth in the different countries and act likewise because they do have to make profits before the quarter ends on June 30, 2010.
Merkel is having to field cries of terror from the German banks as they sit back and watch their Countries money head for the exits. I also think it’s a wise move to push for deflation. This is debt we are talking about and miss priced assets. The faster they force them down the quicker they will rebound, unlike all of us in the United States. This is a debt and asset value issue and it is coming to America soon. Uncle Ben can not head this one off. It’s impossible.
I got the feeling EU will come out OK, while US don’t. EU is doing what vietnam did few month back. devalue, then increase interest rate, and export to asia. This might work actually.
at the expense of US export of course, the minute euro hit 1.15, nobody wants to buy US products. (chemicals, machines, planes) If it hits parity, US will have lost decade.
Remember EU is a much bigger economy with more people than US. closer to cheap oil too.
basically, this is EU abandoning US..
You know you hear Uncle Ben talk about the feed back loop over and over. I have a hunch that the market is going to teach Ben a lesson about what a feed back loop is.
US / EU intervention = the market pounds back harder & on and on and on. I read this as the market saying game over! This is obvious when you look at the Libor.
This is CHECK MATE Ben, CHECK MATE. You can’t move Ben. You were wrong to take the political high road here. WRONG WRONG WRONG
Although, Uncle Ben will be laughing his ass off reading these posts if this is ends up being about a new world currency! I wonder if Rahm Emanuels mug will be on the paper?
i don’t get it. can some one help. how far of am i. so we are making more and more dollars and soon inflation will rise and then the fed will raise interest rates to try and keep that controlled but then what effect does the rising interest rates have on all the trillions in interest rate derivatives????
Too bad the German gov’t didn’t short the world before putting out their announcement. They’d have recovered half the money!
–sghammer
And how do you know they didn’t?
Unfortunately for the Greeks, it was not true! Greece is not leaving the euro! The Greek people striked and demonstrated massively again and look what happened to the markets! This is no coincidence and is happening to often to think that it does not matter. The defiant Greeks are pointing the direction. When communities wake up and revolt against austerity measures, markets beware!
What they couldn’t do in Germany is being played out on the Dow, one suspects. Playing into sentiment probably means the shorts have the game for now. Interesting, let’s see how that interacts with the populist reform regulations that are now sweeping the world.