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Germany to Ban Naked Short Sales


Take with a grain of salt hyperbolic commentary about short-selling ban; this is what it means.


US stocks are coming under increasing pressure this afternoon as the Deutsche Presse-Agentur news agency reports that Germany is proposing a ban on naked short-selling beginning at midnight.

While equities investors and traders are going to focus on the short-selling ban in terms of stock trading, the real news in the German proposed short-selling ban is that it's possibly going to include bans on European sovereign debt and even CDS (credit default swaps) on sovereign debt. This is what I wrote last week:

There are basically only two ways to effectively end the sovereign debt crisis:

1. for global lawmakers and central banking policymakers to essentially enforce a global ban on credit derivatives, or,

2. for Fat City [European] governments to somehow claw their way out of deficits and back toward solvency at the very least, or at best, and most unlikely, toward surplus.

Number one seemed like a long shot a week ago, but this present proposal means a ban on credit derivatives may be not quite as far-fetched as many think. What will be necessary, however, is for such a ban on credit derivatives to gain traction beyond simply the eurozone and find support among the Group of 20 Finance Ministers and Central Bank Governors. The market, knowing such support for an outright ban remains a long shot, has taken the news as a negative, essentially calling this move a bluff. Indeed, it does have the potential to backfire dramatically, creating incentive for bearish bets against sovereign debt to actually increase and further pressuring spreads.

Regardless, take with a grain of salt the hysterical and hyperbolic commentary you are going to be reading about the proposed ban from the mainstream media and punditry. This is simply one battle in a larger, longer war.

The European Central Bank has actually taken some very shrewd maneuvers, pitting speculators against one another to do much of their "dirty work" for them. Credit derivatives speculators -- mainly hedge funds -- are being matched against credit investors who have been assured they have the backing of the ECB to protect them. If you go back and read Ben Bernanke's 2002 speech on Deflation: Making Sure it Doesn't Happen Here, then you can see much of what he prescribed actually taking place, particularly with respect to this pairing off of debt investors versus credit derivatives speculators. This gambit is taking place with the goal of forestalling the crisis so that number two, above (governments to somehow claw their way out of deficits and back toward solvency), can have time to work. Whether one believes that is even plausible is a different question entirely, but certainly not today's business if the move to stabilize sovereign debt succeeds.

More tomorrow. But again, the biggest news in this is the step toward an outright ban on credit derivatives. As I hoped to make clear last week, the market has attempted to price in what will happen if attempts to solve the sovereign debt crisis fail, but I don't think it has priced in what will happen if a solution succeeds. Food for thought.

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No positions in stocks mentioned.

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