Some commentators on the surprising and not terribly well received unilateral move by Germany to ban naked credit default swaps on sovereign debt and shorting of bank stocks assumed it was intended to placate domestic voters. Merkel’s move to join the Eurozone rescue effort was wildly unpopular at home; taking a tough line with speculators looks like a desperate gesture to restore a semblance of cred.
And indeed, Wolfgang Schäuble, Germany’s finance minister, offered a credible-sounding defense in an interview in the Financial Times….if you were living on Mars and hadn’t witnessed the market’s raspberry:
He wants urgently to rewrite the rulebook of the eurozone to prevent any such crisis happening again, and at the same time to revive the momentum of international negotiations on tougher regulation of financial markets. He has returned to the idea of an international financial transaction tax, to make financial institutions share in the costs of the crisis, even if it can be agreed only inside the European Union….
“I’m convinced the markets are really out of control. That is why we need really effective regulation, in the sense of creating a properly functioning market mechanism.”….
“A market does not function properly if the risks and rewards are completely unbalanced,” he says. “We need transparency. Given the complexity of modern technology, the individual needs a chance to judge what he is doing. That’s why we need standardisation of products. And we need transparency for all market participants.
“We must regulate over-the-counter transactions, and we must also focus on the ratio of financial transactions to the real exchange of goods and services. They bear no relationship to each other. I understand that we need new financial instruments to cope with the huge financial tasks that we face. But, forgive my saying so, minimum profits of 25 per cent are simply unimaginable in the real economy. It isn’t healthy.”
Yves here. These are all sound objectives. Unfortunately, the unexpected move of unilaterally banning certain types of shorts does not appear central to these bigger aims, and may have served to undercut progress towards Schauble’s goals.
But the “what you see is what you get” assessment seems more plausible, that the Germans are worried about speculators….because they legitimately feel vulnerable. The US and UK also implemented bans on short selling financial stocks during the financial crisis. Now these bans are ham handed and appear to be not terribly effective (but the inability to run experiments in parallel universes makes it difficult to reach definitive conclusions).
Now why do the Germans in particular feel a tad nervous? Well, Germany, like the UK and Switzerland, has a banking system so large relative to its economy that it cannot credibly backstop it if it goes seriously off the rails. The problem is more acute in Germany because it does not control its own currency (as it cannot simply throw whatever it takes at the banks and if need be, “print” later; by contrast, the risk to the UK and Swiss banking system comes from its banks’ foreign currency exposures).
Bloomberg gives tonight’s sighting of rising nervousness in interbank markets:
The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, widened to 25.3 basis points from 24.8 basis points yesterday, the biggest gap since Aug. 13. A basis point is 0.01 percentage point.
Short-term funding costs are a “good measure” of the concern in markets that Europe’s debt crisis might spread, [Jeff] Rosenberg [of Bank of America Merrill] said.
“Libor-OIS spreads are on the rise again and that tells you the systemic risk of a restructuring, as the outcome for the European sovereign credit crisis, has not been alleviated,” he said.
Yves here. German banks, particularly the clueless Landesbanken, were major stufees for toxic US mortgage paper. Eurobanks in general are behind US banks in cleaning up their balance sheets (yes, Virginia, we are not number one in extend and pretend). Ambrose Evans-Pritchard argues that the German banks are behind their EU peers (hat tip reader Swedish Lex):
A year ago, Germany’s financial regulator BaFin warned that the toxic debts of the country’s banks would blow up “like a grenade” once hidden losses from the credit crisis caught up with them.
An internal memo at the time showed that BaFin feared write-offs might top €800bn (£688bn), twice the reserves of Germany’s financial institutions. Nobody paid much attention. But the regulator’s shock move on Tuesday night to stop short trading on banks, insurers, eurozone bonds – as well as a ban credit default swaps (CDS) on sovereign debt – has left markets wondering whether the slow fuse on Germany’s banking system has finally detonated….
German lenders have the lowest risk-weighted capital ratios in the world after Japan. They were slow to rebuild safety cushions after the sub-prime crisis, and now face a second set of losses on Club Med holdings. Reporting rules have let Landesbanken delay write-downs, turning them into Europe’s “zombie” banks….
The short ban set off instant capital flight to Switzerland. BNP Paribas said €9.5bn flowed into Swiss franc deposits in a matter of hours on Wednesday morning.
The Swiss central bank intervened to hold down the franc. This caused the euro to shoot back up against the US dollar after an early plunge. The euro had already bounced off “make-or-break” technical support at $1.2135, the 50pc “retracement” of its entire rise since 2000, but any rally is likely to be short-lived.
Yves here. We are still getting some remarkable whisting in the dark from other analysts. From a different Bloomberg story:
“The euro depreciation is very good news for the region” because the rest of the world economy is expanding, said Charles Wyplosz, head of the International Center for Monetary and Banking Studies in Geneva. “This is going to bring a welcome boost that may save the euro zone from outright recession.”
Yves here. Um, the more accurate characterization is that Europe has committed itself to a deflationary course of action and currency depreciation will serve to export it. With US growth less than robust, and China in a tough spot (its expansion is dependent on increasingly ineffective borrowing), the global
“growth” story is fragile.
And if the European financial system starts wobbling, all bets are off. More cheery information from Evans-Pritchard:
Tim Congdon from International Monetary Research said deposit data from the ECB shows that there was a “major run” on Club Med banks in the second week of May. Some €56bn of interbank lending facilities were withdrawn, probably as citizens in the South switched funds to banks in the eurozone core. Bank reliance on the ECB lending window jumped by €103bn – or 22pc – in a week.
“It was extreme and very sudden, probably on Friday afternoon. The eurozone was undoubtedly in peril,” he said.
Yves here. The bailout plan shifted risk from the periphery to the core of Europe, and the core, upon examination, does not look too solid. Prepare yourself for a rough ride.