All attempts to figure out how bad a crisis will get depend on the assumption that none of the parties will do something stupid.
Germany just did.
Yesterday, May 18, without any discernable coordination with the other members of the European Monetary Union, Germany imposed a ban on naked short selling. Other countries such as Belgium have implemented such bans on shorting stocks that traders didn’t actually own as a way to limit what national governments regard as speculative attacks on bank shares.
But Germany went one, no, make that two, steps farther. It banned naked shorting not only against a list of 10 German banks but also against bonds issued by European governments and against credit default swaps.
The euro dropped yesterday, May 18, to another four-year low against the U.S. dollar on the news.
The damage—beside the day’s hit to the euro–here is three fold.
First, by moving alone and in what appears to be haste, Germany has unnerved financial markets across Europe. Are countries going to strike out to defend their own interests with the devil taking the weak and the slow? Has Chancellor Angela Merkel’s government panicked? You can understand why financial markets would like answers to those questions before anyone extends credit to anyone in Europe.
Second, investors—not just speculators—use credit default swaps as a way to build hedges against a default by a borrower. Sometimes those hedges can get rather complicated and they might even involve a short against an asset that the hedging investor doesn’t own. Limiting the availability of insurance at a time when markets are worried about the credit-worthiness of European banks and governments will force some potential lenders to stay out of these markets at exactly the time when these markets need more liquidity. There’s no evidence that points to a surge in the speculative use of credit default swaps. According to the Depository Trust and Clearing Corp. net outstanding credit default swaps on Greek debt totaled $7.7 billion in the week ending May 7. A year ago the total stood at $7.8 billion. Â
Third, today politicians have decided to ban naked short-selling of credit default swaps. What bans and regulations are on tap for tomorrow? Nobody likes to put money at risk when there’s a good chance that the rules will change overnight. The big risk now in the Euro Zone is a credit crunch that will lock some countries and some banks out of the financial markets so they won’t be able to roll over their short-term debt or raise new capital. Germany’s action has just increased the likelihood of exactly that kind of problem.
The euro debt crisis has always had a strong political element from the very beginning when it became clear that Greek politicians had lied about the size of the government’s budget deficit to today when no one is quite sure that German legislators will vote to approve their country’s share of the $1 trillion rescue package.
And one of the reasons that it has been so hard to put this crisis to rest is a suspicion that Euro Zone politicians just aren’t up to the job. Even at this stage in the crisis, yesterday Spanish finance minister Elena Salgado was spending her time asserting that her government would never give European regulators the power to rewrite her country’s national budget. Well, okay. Sure. But how about a credible budget reduction plan from the finance minister first/
Germany’s move yesterday just raised those fears another notch: If the Euro Zone can’t even count on the Germans for smart financial policy, then who is going to provide the leadership to put a end to this crisis?
A financial crisis is always to a high degree a crisis of confidence. Right now the financial markets have very little in Europe’s governments.
Jim, I agree with you that European governments have made this crisis worse by failing to take timely, decisive action. But I disagree with you that the German government’s banning of naked short selling & credit default swaps is stupid. Frankly, it’s refreshing to see other governments take action against these financial games that create paper profits for hedge funds & speculators often at the expense of us little investors. If the hedge funds & speculators take their money & go elsewhere, that’s fine with me. Too bad the U.S. doesn’t have the brains or the guts to implement similar reforms against abusive financial games. When it comes to commonsense financial regulation, it’s apparent to me that Washington is on the trailing edge, not the cutting edge. One example is regulation closing corporate tax loopholes against multi-national corporations that use holding companies in tax treaty countries like Hong Kong & Barbados to avoid paying proper taxes. China has just closed that loophole in a way that makes the U.S. look stupid.
The Eurocrats seem intent on making the current EU crises worse with every turn they take.
Economists and finance ministers are looking for a way out of the current “world” debt crisis. The European sovereign debt problem is just a part of this, although it is currently the part causing the most grief. Growth is looked at as a way out of these problems, so people are trying to figure out who can be the engine of growth that will pull the world economies out of their debt spiral.
Everyone has been talking about the “China bubble”, but it’s the “Euro bubble” that bites.
Looking for best growth prospects in BRIC.
As Jim has so well described, China has major problems. An asset bubble needs to be resolved and they are probably behind the curve in dealing with it. Since China is, so far, mainly an export driven economy, reduction in spending in their export partners, Europe and the US, will be a negative for them. Russia has many problems: an aging population, uncontrolled corruption, appears to lack the political drive to accomplish needed structural and economic reform and is a predominantly oil and energy based economy. India and Brazil have a large amount of domestic demand (consumption is about 2/3 of GDP as opposed to 1/3 of GDP in China). On this basis some economists have predicted that they are likely to grow at a more robust rate over the next 5-10 years.
Glad to hear this report about ITUB. It’s in negative, but I decided to hang on.
Bloomberg is running this on Brazil today: “Banco Itau Brazil’s biggest bank by market value, may raise its growth estimate for the country’s economy this year to as much as 8.5 percent, economist Guilherme da Nobrega said.” Which woiuld be astounding since the bank raised its growth projection to 7.5% from 6.5% just la week or two ago.
Euro may be having “shorts squeeze” due to crowding of shorts. There is a huge amount of short interest on the euro right now. GS FOREX analyst predicted that it could go to 125 but should eventually continue down. Fair value is predicted at 118 to 120 if Eurozone overcomes debt problems and recovers. Markets probably want some concrete evidence of moves toward fiscal union. It should continue down until then.
The EUR is rallying hard today, but equities are down…this is a change. I just can’t figure anything out here. Anyone have a clue?
When Paul Krugman and Meg McArdle agree on something, and that something happens to be the EU, be afraid for the future of the EU.
http://www.theatlantic.com/business/archive/2010/05/paul-krugman-no-ones-labor-market-is-flexible-enough-to-make-the-euro-work/56878/
Ed, I read a few things about why Euro is not dropping further. They talk about the invisible hand…the world central banks. Especially Japan, whose exports are in direct competition to that of the Euro (auto and precision electronics), doesn’t want Euro to drop further as it will damage it’s own export competitiveness. Also, it’s not good for all European govts if they allow Euro to just drop like a stone. Too many things at work…it starts to make no sense if we consider individual factors, at least in the short term.
Mr Vann,
Basically, the euro went up today on a rumor that Greece was leaving the EU, which Greece later denied.
Surprisingly, the euro hasn’t dropped much since that happened. Other rumors include the Swiss are holding up the euro, and that the EU has another solution they are working on.
Again, these are just rumors. But the market will move on rumors.
If I was Germany I would want naked shorts to slam Greek bonds. I’d buy a ton of ’em up at huge discounts, lobby IMF for a bailout, and sell the bonds for no capital gain. That’d solve the austerity problem, reduce debt burden, and make things a hole helluva lot easier.
What are these bonds selling for anyway? Buying them up at a discount is a pre-packaged bankruptcy that saves face.
Come to think of it, maybe US should head fake the markets to plunge bond values and do the same thing. How about jawboning higher rates, watch the market react, then start buying at a discount rather than selling. It’d be funny as hell listening to the bankers scream poverty again…
Musing over.
Ed,
If you find any info about the euro, would love to hear about it. I think a lot of us have jumped on the EUO bandwagon. Always appreciate yours and other insights to help me sort things out …
Re: Itub, the reports are that BOA has an existing 5.56% stake, of which it will be entirely divested once it sells its common and preferred shares. Hence, no dillution. (and the BRF is also not having a good day so Itub’s tankage may be only partially explained by BOA’s intended sale.)
how do you see the impact of euro devaluation in american company p/ls with a larger euro business. these companies will see a decline in their revenue when they tranlate it into USD at year end?
I think this was just ment to be an argument for good taste, I mean I’ve seen pictures of German stock brokers, and I too would prefer that they wear clothes when selling short….
bsdgv… can you enlighten me on the BofA action? So are these new shares that are diluting or selling of existing shares? I have not been able to determine from accounts I’ve read.
Jim,
Right now, the euro seems to be meeting lower resistance at $1.22. Any clue why?
> ITUB is down 7% as of this post and is on Jim’s watch list. Anyone else tempted to jump?
Bank of America to sell Unibanco stake. In a move expected to raise $4B, Bank of America and Brazilian lender Itau Unibanco announced that BofA will sell 56.5 million shares to Itau SA, Unibanco’s controlling shareholder, and do an offering of 188.5 million preferred
shares of Unibanco the week of May 31, after which Bank of America will no longer hold any position in the Brazilian bank.
Off topic:
ITUB is down 7% as of this post and is on Jim’s watch list. Anyone else tempted to jump?
Jim,
Not only that (the whole thrust of your argument…stupidity, lack of credible leadership, etc), but this turns up the heat on the notion,”Sell in May and go away”, to sell, period, until 1. Europe gets it right, 2. that may be a very long time, and 3. Equity prices will be supressed, depressed and kicked to death because investors are more interested in the fiscal issues across the pond more than good (that is, getting better) numbers from economists and businesses here at home. Let’s face it, the markets have sold the hell out of any good news here in the US. Later, and I don’t know a time line on “later” (perhaps you could shed light) hopefully bargin hunters will take $ off the sidelines and go shopping…when, is anyone’s guess!