War on Naked Shorts: EU Bans Short Selling

Politicization of the marketplace has been broadening. Trading curbs are not only applied to commodities but to short-selling as well.

From Bloomberg,

The European Union reached a deal as part of a short-selling law that will pave the way for an optional ban on naked credit-default swaps on sovereign debt.

Poland, which holds the rotating presidency of the EU, and lawmakers from the European Parliament reached the accord at a meeting in Brussels yesterday.

Under the deal, traders may be prevented from buying CDS on government bonds unless they either own the sovereign debt or other assets whose price moves in tandem with it. Nations will have the right to opt out of the measure if they detect signs that it may affect their borrowing costs.

“These balanced measures will ensure that sovereign CDS are used for the purpose for which they were designed, hedging against the risk of sovereign default, without putting at risk the proper functioning of sovereign-debt markets,” EU Financial Services Commissioner Michel Barnier said in a statement.

German Finance Minister Wolfgang Schaeuble and lawmakers in the European Parliament have called for a ban on naked CDS trades on government debt over concerns the practice fueled the euro zone’s debt crisis. Germany already has restrictions on using swaps to bet on sovereign defaults.

Some European governments have also criticized the use of short selling to bet against bank stocks, arguing that the practice has roiled markets. Volatility that sent European bank stocks to two-year lows led France, Spain, Belgium and Italy in August to impose temporary bans on short selling that remain in force.

Opt-Out Clause

Under yesterday’s deal, national regulators will be able to suspend the CDS ban in their territory at the first signs that it may harm their sovereign debt market.

The opt out-clause won over some critics of possible bans.

“I never signed up to the belief that a ban on uncovered sovereign CDS would have any positive impact,” Syed Kamall, who represents London in the EU Parliament, said in an e-mailed statement. “However, I’m reassured that member states will have the ability to opt out of the ban, if they see signals that sovereign debt markets are distressed.”

The European Securities and Markets Authority will give a non-binding opinion on whether a national regulators’ decision to drop the ban makes sense. ESMA coordinates the work of national markets regulators in the 27-nation EU.

Renew Indefinitely

While the suspensions will in theory be temporary, regulators will be able to renew them indefinitely. Under the terms of the agreement, existing CDS positions will be grandfathered until they expire.

CDS are instruments that act as insurance for the buyer against losses on bonds. The practice becomes naked when someone buys swaps on debt that they do not actually own.

The measure forms part of a broader agreement on an EU law that will also curb naked short selling of stocks and government bonds.

All these curbs seem like a 'comprehensive strategy' to preserve the status quo

Global governments want to see LOWER commodity prices because this allows them some space to apply more inflationism to uphold political goals when deemed as expedient by the incumbent authorities. Also this allows them to declare victory against ‘inflation’ or to swagger about the success of their policies.

Governments do not want see the public go SHORT on sovereign debt because the welfare state based governments badly desire to maintain their spendthrift -borrow and spend-ways, whose benefits accrue to the political class, their voting constituent groups and their cronies.

Instead governments want HIGHER stock markets, particularly the banking and financial sectors as these institutions hold much of sovereign debt in their balance sheets as Basel mandated ‘risk free’ assets. Remember, banks serve as the PRINCIPAL conduits in the financing of the welfare state.

That’s why a ban on naked shorts, a form of price control, has been designed NOT only to preserve the access to funding by the welfare state, they are meant to keep banking and financial stocks AFLOAT.

Besides for central bankers higher stock markets PROMOTE aggregate demand via more spending (regardless of what kind of spending).

Yet these policies are directed to benefit holders financial assets at the expense of the productive sectors of the economy. Wealth/Income inequality and political inequality anyone?

To add it up: The overall direction of global market interventions has been to promote Bernanke’s doctrine of the wealth effect worldwide and to preserve the welfare state.

The caveat is that all these cumulative actions presumes that market interventions will effectively skew the law of demand supply in their favor—a utopian scenario.

Occupy Wall Street guys, have you been listening?

The Zombie-fication Of Financial Markets

World markets appear to be increasingly transmogrifying into zombie markets.

This from the New York Times,

``A week after rattling global bourses and annoying allies with a unilateral ban on some forms of financial market speculation, Germany went much further Tuesday, proposing a law that would greatly broaden restrictions on several instruments that investors use to bet against stocks, bonds and currencies.

``Despite criticism that market regulation will be toothless unless it is enacted globally, the German finance minister, Wolfgang Schäuble, on Tuesday proposed extending a ban on what the draft legislation called “certain transactions that amplify the crisis.”

``There is broad support for such measures among leaders on both sides of the Atlantic, and some of the proposed rules are already in effect in the United States. Other European nations, however, have complained about Germany’s decision to act alone.

``“What the Germans are doing would be all the more effective if it were done at a coordinated European level,” Chantal Hughes, a spokeswoman for Michel Barnier, the European Union internal markets commissioner, said Tuesday.

``The draft law, released Tuesday by the German Finance Ministry, expands a ban on so-called naked short-selling to all stocks that have their primary listing in Germany, as well as on government bonds issued by euro countries.

``The law, which will take at least until September to win passage in Parliament, would also ban naked short-selling of the euro, and enshrine a ban on use of so-called credit default swaps to bet against European government bonds."

What the news reveals is how mainstream politicians think. They believe they can:

1.control or manipulate the markets at will, with no unintended effects. (yes, they seem to think that as deified entities, they are far superior to market forces and above the laws of scarcity)

2. prevent markets from revealing their natural state by controlling price signals. Thus, a market collapse markets isn't in their books. (yet the markets have been collapsing)

3. paper over solvency issues with massive liquidity injections and price control measures.

More demand for zombification...

From BCA Research,

``History shows that whenever authorities limit the commitment to a particular value, it encourages investors to quantify their worst case scenario (which during times of financial sector strains can be horrific), leading to a panic and meltdown. It is only once policymakers provide a credible unconditional commitment to put an end to the turmoil that investors’ fears calm, allowing financial markets to stabilize. Unfortunately, the “open-ended” nature of European policmakers’ commitment has come into question: German authorities moved to prevent speculative attacks by banning naked short selling for 10 German bank stocks as well as for CDS on regional government debt. Similarly, the ECB continues to reiterate their intent to sterilize purchases of public and private debt securities, i.e. not quantitative easing. The decision on short selling should not be a large surprise given that the primary motive of German politicians to participate in any rescue package has been to protect their domestic banks. The only good news is that German lawmakers have approved its country’s share of the $1 trillion bailout package. Still, the ECB will need to be much more forceful in its reflationary efforts. Bottom line: The ECB should reassure markets that any expansion of its balance sheet will be unwound in an orderly fashion once the economy is on a stable footing. In the meantime, substantial quantitative easing must be undertaken."

First of all, the claim of "history" as reference is dubious. That's because all these debt binges, rescue efforts and reflationary measures, have been unprecedented in scale and in scope, so there is basically no basis for comparison.

Besides in our own Asian crisis, an open-ended rescue was not an option, instead we were prescribed to adapt "austerity" programs via structural adjustment programs (SAP).

Only today, do we see the "need" for massive or aggressive substantial quantitative easing. In short, money printing as a policy is selective and conveniently applied, where it involves the developed nations. It becomes not only a fashion but a false sense of entitlement.

Yet as we keep pointing out, even Keynesian Hyman Minsky believes that massive government intervention leads to systemic bubbles by engendering the moral hazard conditions that sow the seeds of a bubble.

And likewise, as noted above, substantial QE's or money printing won't solve the solvency issues. They merely "kick the can" or defer and even aggravate the day of reckoning. Yet, history has never been quite digested, but misrepresented.

In the words of Thomas Paine, ``I remember a German farmer expressing as much in a few words as the whole subject requires; "money is money, and paper is paper."

``All the invention of man cannot make them otherwise. The alchemist may cease his labors, and the hunter after the philosopher's stone go to rest, if paper can be metamorphosed into gold and silver, or made to answer the same purpose in all cases."

If printing money is, indeed, the elixir to the world's problem, then Zimbabwe should have been the most prosperous and the world's largest exporter.

Besides, based on this line of reasoning, why do we or anyone need to work, if, at all, money printing can solve the issue of scarcity? Why do we even need the markets?

Germany Bans Short Selling, Another Scapegoating The Markets

Governments almost always believe that market has been the culprit for most of the ills in society. And that when push comes to shove, their instinct is to resort to palliatives: throw money at the problem, regulate or tax.

Since the markets has not stabilized even after the Bazooka or Shock and Awe monster $1 trillion bailout, of the not only of Greece, but the entire Euro Union, last night, Germany banned short selling in European bonds and credit default swap and shares of select industries in the stock market.

This from Bloomberg,

``Germany prohibited naked short- selling and speculating on European government bonds with credit-default swaps in an effort to calm the region’s financial markets, sparking anxiety among investors about increasing government regulation.

``The ban, which took effect at midnight and lasts until March 31, 2011, also applies to the shares of 10 banks and insurers, German financial regulator BaFin said late yesterday in an e-mailed statement. The step was needed because of “exceptional volatility” in euro-area bonds, BaFin said."

The problem is that these bans introduces more risks by not allowing the markets to reflect on the fundamentals via price signals.

Besides, excessive government spending financed by debt coupled with insufficient revenue, which is the source of the Euro's problem, hasn't been caused by the markets but by extant policies.

So the German government is simply looking for another scapegoat.

While the stockmarkets in Europe did react positively, perhaps due to some short covering on the issues affected by the ban, US stocks got slammed and the Euro cratered!

Regulators don't seem to realize that banning naked shorts hardly produces the intended effects and instead creates an aura of heightened uncertainty.

So aside from regulatory risks, these actions may suggests of an act of desperation or act of concealment of problems.

At the near climax of the Lehman episode in 2008, the US government reacted the same way, by instituting a ban on naked short selling in mid September as Lehman filed for bankruptcy.

And instead of the consequences going in the way of the regulators, the US markets collapsed! See below...

The blue arrows mark the time where naked short bans had been imposed.

Japan followed in November of the same year (above window), yet the results were the same...a failure to stem the hemorrhage.

The more governments manipulate the markets, the unstable they will be.