Yesterday, the German Finance Ministry announced a ban on the ‘naked short-selling’ (the practice of betting that the price of a share will fall without ever actually owning the share or planning to do so) of ten of the county’s largest banks and on betting against government bonds using credit default swaps. This could be a sign that the Germans fully anticipate further slides in the value of European debt, both public and private.
Some (like Money Week) view this move as a political ploy to re-position Merkel’s party in reaction to the trouncing they received in the recent regional elections. However, I think that this pair of bans are more realistically viewed as a damage-limitation exercise, an attempt to artificially protect the banks and German government from what could turn out to be a market raid on their shares and bonds respectively.
The brute fact is that the Eurozone is in serious trouble, saddled with enormous amounts of government and personal debt; there is a high risk of Greece, Portugal, Italy and Spain defaulting. If this were to happen, the Germans would be among the biggest losers. German banks own hundreds of billions worth of the debt of Greek, Spanish, Portuguese and Italian banks, and now the government (as of last Monday) is committed to protecting the bonds of the governments of these countries. In February, the WSJ estimated that German banks had about $240 billion outstanding with Spanish borrowers alone.
If any of the major banks of the PIGS (one ‘I’ now, congratulations Ireland!) were to fail, investors would question whether the major German holders of their debts would be able to survive. Similarly, the sovereign defaults of any of these countries would have disastrous consequences for German public finances and the value of German bonds.
Yesterday’s bans, then, seem to be an attempt by the Germans to mitigate the damage resulting from the continuation of the Eurozone debt crisis. It is a ‘let’s cover our backsides’ operation on behalf of the Germans and the country’s major banks, suggesting that the Finance Ministry now accepts what many have been saying: the crisis will get a lot worse before it gets better, the vulnerable countries and the holders of their debt are in for a rough ride. Paradoxically, these very actions may create a self-fulfilling prophecy, sending markets out of control on a ‘they must know something I don’t’ line of reasoning. Surely no Finance Ministry would ban betting against major banks and government bonds unless they expected the market to undertake such trades.
The travails of the Euro make for a fascinating economic specimen, but this an experiment where the economic well being of hundreds of millions of citizens is at stake. The PIGS have lost their last-ditch tool, currency devaluation, in return for increasingly insignificant economic benefits. The German actions could be interpreted as a signal that the Eurozone is in for more trouble ahead.