Germany Issues Unilateral Ban on Short Selling

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As the German government banned the naked short selling of EU government debt and the stocks of 10 leading German Banks, the markets reacted with a mixture of disbelief and anger as billions were wiped of the value of shares across the main European bourses. What does this have to do with the US and why should it bother us what the Europeans do to hamstring their financial services sector?

Financial markets more than any other are a global business nowadays, if for no other reason than actions taken in one impact exchange rates and growth prospects that have a direct impact on fortunes in the US. The US dollar long on a slide has “enjoyed ” a period of robust strength these last few weeks as investors have dumped overseas assets suddenly perceived to be risky and brought safe US treasury debt and domestic stocks. Although that is good for servicing US debt requirements it is bad for the exchange rate as a weaker euro and stronger dollar choke off the early recovery in exports US manufacturers have been enjoying. The trade gap had already been widening since early this year and a stronger dollar will only encourage the import of more BMW’s and Mercedes and depress the exports of machine tools or earth-movers.

There could be some comfort taken if the action by the German financial regulator BaFin was necessary but some see it as a sop to beleaguered Angela Merkel’s party facing wavering support on the left. The kindest conclusion is that Germany was simply trying to cynically manipulate the bond market ahead of a large sale. The sense among EU members that Germany had acted solely in its own interests was compounded as an auction of £3.7bn of German government bonds within hours of BaFin’s announcement saw the country issue new debt at the cheapest rate since 1998, helped largely by the so-called “short squeeze” created in the bond market by the short selling ban, which forced many investors with short positions to buy debt. As an article in the Telegraph says coming a day after Spain struggled with a debt sale of its own, many EU governments will have found it hard to escape the conclusion the German ban was partly a cynical attempt to improve Germany’s finances.

Tempting though this theory is, the fallout has been so severe it is unlikely the explanation is that simple. Investors fear BaFin knows more than they are letting on and their move covers deeper problems. In a further Telegraph report the issues are analyzed in more detail than we have time for here but briefly a BaFin report a year ago voiced concerns that European bank write-offs from credit default swaps could top $800bn once losses caught up with them. The regulators shock move has many asking what is not being said about the state of German CDS losses and whether on lending to the Club Med economies could be about to push some over the edge. The short ban set off a flight of capital to Switzerland, BNP Paribas is quoted as saying US12bn flowed in Swiss Francs in a matter of hours. Another source at International Monetary Research is quoted as saying there was a major run on Club Med banks as nearly US$ 70bn of interbank lending was withdrawn, bank reliance on the ECB jumped by 22% or US$125bn in one week.

If investors fears are realized (and they have a tendency to be self fulfilling when the herd mentality sets in) growth in the Eurozone is likely to be further depressed for years. There is even the chance of a double dip as interbank lending dries up and businesses are once again starved of capital as in 2008/9. So distant and peripheral as Europe’s banking problems may seem the reality is we all have an interest in seeing them sort out not just their financial problems but the political issues that caused them.

–Stuart Burns

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