The Shorting Ban Predictably Fails

Not surprisingly, the effect of shorting restrictions in various European stock markets failed to have the intended effect – or rather, the effect lasted only for a few days. Once the shorts were finished covering, everybody went back into 'sauve qui peut' mode and the selling immediately resumed with great gusto. Could anyone have known? As we noted at the time, 'we wonder why the authorities even bother'. Such restrictions have never stopped a decline from unfolding and there is a lot of historical evidence that argues that they in fact exacerbate declines. Numerous studies on such bans have all come to the same conclusion: they don't work.

This makes sense, as they reduce market liquidity and in fact remove an important source of buying power from the market. After all, shorts need to eventually buy back what they shorted if they want to take their profits. Moreover, restricting the shorting of specific stocks that are components in indexes that also trade in the form of futures contracts inhibits index arbitrage. On expiration Friday, French regulators saw themselves forced to temporarily remove the just introduced shorting restrictions again for this very reason.

As Bloomberg reports:

France relaxed a ban on selling banks short, trying to calm index futures traders concerned the rule would keep them from exchanging contracts when they expire today.

Investors who are short index futures that include bank shares can replace the holdings with new contracts, according to the AMF, France’s financial regulator. Speculation the ban would prevent that may have contributed to volatility yesterday, when European stocks plunged the most since March 2009.

“They really should have thought about that earlier,” said Trung-Tin Nguyen, a hedge-fund manager at TTN AG in Zurich. “If you want to change the rules of the game, then do it right.”

In a short sale, speculators borrow shares and sell them, betting they will be able to purchase them later at a lower price. France prohibited new short positions on financial stocks last week after Societe Generale (GLE) SA, the nation’s second-biggest bank, plunged the most since 2008.

Adding to concern yesterday were rules in the original ban designed to quash so-called synthetic positions in which traders bet against banks by shorting an index and buying every non- financial stock it contains. Some brokerages insisted that customers selling futures on gauges proved that they owned financial stocks, according to e-mails sent to clients and obtained by Bloomberg News.

The Stoxx Europe 600 Index plummeted 4.8 percent yesterday as U.S. economic data trailed forecasts, two Federal Reserve officials said the central bank shouldn’t act to protect stock investors and Swedish regulators warned that lenders are unprepared for a freeze in money markets. Societe Generale slid 12 percent as the Wall Street Journal said that U.S. regulators are stepping up scrutiny of Europe’s largest lenders.

“Any uncertainty about what products can be traded, when and where, is bad for the market,” Richard Perrott, exchange and diversified financials analyst at Berenberg Bank in London, said in an interview yesterday. “There was huge confusion today what participants could and couldn’t do, which isn’t helpful when there are large share price movements. Potentially the regulators didn’t think this through.”

Futures on France’s CAC 40 Index (CAC) expiring tomorrow plunged 5.6 percent to 3,071.5 at 8:35 p.m. in Paris yesterday.”


(emphasis added)

You bet the regulators didn't think this one through. It's a wonder they haven't yet banned credit default swaps as it were, since the buyers of CDS evidently can only profit from 'negative outcomes' (note that even George Soros, who really should know better, thinks they are somehow odious instruments). So what about the sellers of such swaps? Shouldn't they be punished for being unduly optimistic? Kidding aside, here is what would probably happen if trading in CDS on sovereign debt and or corporate debt were banned: the underlying bonds would crash before our vaunted regulators could ask 'what happened'.

As an aside, market places elsewhere immediately reacted to the European regulators latest exercise in shooting themselves into the face by rolling out products that would allow people to take the positions that they could no longer take in Spain, Italy, France and Belgium. As per this press report:

“A small U.S. derivatives exchange on Thursday rolled out contracts that allow traders to take bearish positions on European stocks affected by new short-selling restrictions, highlighting the tough task regulators can face in trying to limit market activity.

OneChicago LLC developed the contracts in the week since the tougher short-selling rules were introduced in an effort to limit market declines, with products linked to exchange-traded funds composed of stocks listed in France, Spain, Italy and Belgium.

"This is another way to get exposure to those markets without touching those foreign exchanges," said David Downey, chief executive of OneChicago. "When we heard about the short-selling bans in those countries I instructed our staff to go through and find any ETFs based on those countries' markets that we did not currently list for trading."  Downey said in an interview that he didn't anticipate a sharp upswing in volume, but large banks and other financial institutions with long exposures to the affected European markets would be potential users.”

Note here who Mr. Downey identified as the 'potential users' of these new instruments – institutions wishing to hedge their exposure. Kudos by the way to the CLSA publication 'Greed & Fear' that has advocated for two years or longer that investors should 'hedge their long exposures by shorting Western financial stocks'. This has by now turned out to have been excellent advice indeed.

As an aside, has anyone else taken note of the fact that what usually makes these lists of shorting bans are bank stocks? Why bank stocks, and not, for instance, mining stocks? The answer is of course that we remain essentially in a crisis of the fractionally reserved banking system. Considering the huge leverage of European banks (ratios of tangible capital to assets of 1:50 are the norm rather than the exception) not a whole lot must go wrong. Alas, a lot of things obviously have been going wrong and continue to do so.



Italy's MIB Index – so much for the shorting ban – the biggest decliners: bank stocks (i.e., the stocks subject to the ban) – click for higher resolution.



The CAC 40 Paris – after a tiny bounce following the introduction of the shorting ban, it falls again – guess what fell the most. Right, the stocks which are on the 'banned list' – click for higher resolution.



Germany's DAX index. Interestingly, Germany was at the tail end of an economic boom when the market suddenly crashed (unemployment in Germany is still declining as of the most recently published data) – click for higher resolution.



Italy's largest bank, Unicredito, got exactly a two day bounce out of the shorting ban and has since sunk to fresh closing lows – click for higher resolution.



Italy's second largest bank Intesa SanPaolo – it got a four day bounce out of the ban –  which was completely erased in the following two days – click for higher resolution.



Societe Generale, subject of unkind rumors in mid August which it has denied as being baseless, hits a new closing low. The loss of faith was evidently not assuaged by the denials – click for higher resolution.



The chart of BNP Paribas is beginning to look even worse than SocGen's by now – click for higher resolution.



A weekly chart of Deutsche Bank, Germany's and Europe's largest and leveraged up to its teutonic eyebrows. Note that its post 2008 crash rebound peak was put in back in late 2009 already. The market has slowly but surely lost confidence in euro area banks ever since – even those that have ostensibly weathered the 2008 hicc-up in safe and sound condition – click for higher resolution.



Bank shares in the UK continue to crash as well, as demonstrated by this chart of RBS – click for higher resolution.



The Euro-Stoxx bank index – a new closing low – click for higher resolution.



One would think that after all this carnage, there should be a let-up at some point. However, it seems that the markets are very concerned about something  without being able to really identify where precisely the worst risks are hidden, and therefore have decided to sell all the banks, as well as bidding up CDS on their debt.  As we noted on occasion of the publication of the EBA's bank stress test, this test would not achieve its primary aim of 'calming the markets'. In fact, it lifted  just enough of the opaqueness usually associated with bank balance sheets to thoroughly terrify anyone who took the time to look at the details.


Politicians Fail To Reassure

Funny enough, the sovereign debt crisis has eased somewhat in parallel with these recent developments, although it is probably more of an 'eye of the storm' kind of easing. In particular, the ECB's most recent interventions have lowered the yields of Italian and Spanish government bonds considerably from their highs. The question is, what happens when the interventions stop? A quick perusal of the 'GIP' trio's bond yields doesn't bode too well in this context. As you will see further below, CDS spreads on euro area sovereigns are already starting to move higher again.

Last week saw a number of European politicians either voice their confidence or their proposals following the Merkel/Sarkozy non-event. A slightly credulity-stretching show of overconfidence was provided by Greek finance minister Evangelos Venizelos when he let it be known that the latest bailout of Greece is 'not in doubt' in spite of various European countries clamoring for collateral.

“The eurozone's hard-won deal overhauling its rescue fund and extending Greece a euro109 billion bailout is not in doubt, Greece's finance minister insisted Friday, despite five countries' demands for collateral in exchange for their contributions.

Evangelos Venizelos also said the recession in his financially troubled country could be deeper than originally predicted for this year, with output potentially shrinking by more than 4.5 percent.

His comments came a day after The Netherlands, Slovenia, Austria and Slovakia said Thursday they wanted hundreds of millions of euros in collateral like Finland, which struck a deal with the Greek government earlier in the week to receive cash as security for their part of the bailout.

The demands have laid bare the divisions within Europe over how to deal with its debt crisis, which has already seen Greece, Ireland and Portugal bailed out, and has threatened the far larger economies of Spain and Italy.

Although the amount of cash being demanded by the five would probably not be large enough to sink the deal, it could drive up the overall cost of the bailout, which was part of a July 21 eurozone agreement that gave the 17-country eurozone new powers designed to help a country before it is in full crisis.”


(emphasis added)

The market reaction to these assurances speaks for itself – the selling of Greek debt immediately intensified, driving yields almost back to their former highs. The pullback in CDS on Greek government debt has also ended for now.

On the 'irrelevant blather' end of the spectrum, Belgium added its voice in support of the issuance of euro-bonds, which had just been pushed off the table by the Merkel/Sarkozy duo. If we were Belgium, we'd support euro-bonds as well. Belgium is among the most highly indebted sovereigns in the euro-area and has a wobbly banking system to boot. Dexia, Belgium's largest bank by assets, continues to be under great pressure, with its stock falling by 14% last Thursday alone.



Dexia's stock on the road to Zool. Can Belgium's deeply indebted government bail this one out if push really comes to shove? Color us doubtful on that score.



According to Reuters:

“Pressure on Germany and France to take radical action on the euro zone debt crisis mounted on Friday, as financial markets sagged further and Belgium added its support to calls for the region to issue debt jointly.

Belgian Finance Minister Didier Reynders said the bloc should issue common euro bonds and expand its bailout fund to calm repeated market selloffs of government bonds and bank shares of vulnerable debtor countries.  Germany has led resistance to both proposals. Belgium's support for bonds promoted by high-debt nations such as Italy and backed by some European Commission officials will not necessarily tip the balance.

But Reynders' call in the Financial Times for the euro zone had to prove it had "deep pockets" underlined increasing fears among euro zone governments that they would be unable to reassure investors that euro zone banks are safe without drastic action by the 17-nation bloc.

Merkel repeated her criticism of proposals for euro zone bonds, telling a rally of her Christian Democrats this was a "slippery slope" that would probably leave everyone worse off. "Euro bonds would not allow any rights at all to intervene to force discipline on others," she said.

French Prime Minister backed her view, writing in an editorial published in daily Le Figaro that common euro zone bonds without further fiscal consolidation could threaten France's triple-A credit rating.


(emphasis added)

And there you have it – the reason why France has so quickly hopped off the 'let's increase the size of the EFSF' train that it had previously been aboard, and the reason why it likewise declared itself d'accord with the German reluctance to issue euro-bonds is that it rightly fears that this would mean the coup de grace for its vaunted AAA rating – a rating that is as curious as it is undeserved even so (watch for the rating agencies to eventually follow the verdict of the CDS market).

Meanwhile, it should be noted that Mrs. Merkel once again reiterated her opposition to any such plans, as she rightly fears they would undermine what little fiscal discipline there may still exist. As she remarked in a television interview over the weekend according to Bloomberg:


“German Chancellor Angela Merkel attempted to shut the door on common euro-area bonds as a means to solve the debt crisis, saying that she won’t let financial markets dictate policy.

Joint euro bonds would require European Union treaty changes that would “take years” and might run afoul of Germany’s constitution, Merkel said. While common borrowing might arrive at some point in the “distant future,” bringing in euro bonds at this time would further undermine economic stability and so they “are not the answer right now.”

“At this time — we’re in a dramatic crisis — euro bonds are precisely the wrong answer,” Merkel said in an interview with ZDF television in Berlin yesterday. “They lead us into a debt union, not a stability union. Each country has to take its own steps to reduce its debt.”

Merkel has stepped up her opposition to euro bonds since returning from her summer vacation last week, making resistance to common European borrowing a campaign theme of Sept. 4 elections in her home state of Mecklenburg-Western Pomerania. Investor calls for euro bonds intensified last week as concerns about the debt crisis and a stuttering global economy drove European stocks to their lowest in more than two years.

“Politicians can’t and won’t simply run after the markets,” Merkel said in the chancellery interview, her first since returning from a three-week summer break. “The markets want to force us to do certain things. That we won’t do. Politicians have to make sure that we’re unassailable, that we can make policy for the people.”

She is right with regards to the effect euro-bonds would have on fiscal discipline and that they would be the road to a 'debt union' as she put it (i.e., a transfer union). She is also correct with regards to the legal and constitutional issues such bonds would pose. One the other hand, it sounds as if she were inviting the markets to test her resolve, and experience tells us that the markets will accept the invitation and do exactly that.  The pressure will be on until the next make-shift emergency 'solution' is presented. So far, Germany's government has reluctantly agreed to all sorts of concessions when the pressure was on – even while refusing to 'go whole hog'. The latter would be tantamount to political suicide as we have pointed out previously. There seem no good options left from the point of view of a euro area politician these days.


Other Charts

Below is our usual collection of charts of CDS on sovereign debt inside and around the euro area, euro basis swaps and bond yields. Prices in basis points, color-coded where applicable. As can be seen from these charts, the pullbacks initiated by the ECB's purchase of the government bonds of Italy and Spain have not held for long, except in the bond yields of the countries directly concerned. If the markets don't worry about one thing, they worry about another. It is a bit like the communication between vessels that are connected to each other.



5 year CDS on Portugal, Italy, Greece and Spain – the bounce continued on Friday – click for higher resolution.



5 year CDS on Ireland, France, Belgium and Japan – all a touch higher again – click for higher resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – click for higher resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – all end higher on Friday – click for higher resolution.



5 year CDS on Romania, Poland, Slovakia and Estonia – ditto all higher again – click for higher resolution.



5 year CDS on Saudi Arabia, Bahrain, Morocco and Turkey – the Mid Eastern CDS spreads seem to be back on their way to the crisis highs of earlier this year (Morocco is there already, we may have to take a closer look at what is happening there soon), while Turkey keeps following European CDS – click for higher resolution.



5 year CDS on Germany and the US and the Markit SovX index of CDS on 19 Western European sovereigns. CDS on US debt continue their post debt ceiling debate collapse,  while Germany suffers from 'core infection' and the SovX looks like it will soon break out from what looks like a triangle – commonly a continuation formation – click for higher resolution.



3 month, one year and five year euro basis swaps – the shorter term ones remain clearly at crisis levels and indicate dollar funding problems for euro area banks persist – click for higher resolution.



10 year government bond yields of Ireland, Greece, Portugal and Spain – the latter two remain in 'recovery mode', but Portuguese yields appear to be bottoming and Greek yields are once again heading higher (the recent wrangle over bailout collateral probably doesn't help) – click for higher resolution – click for higher resolution.



10 year government bond yields of Italy and Austria, UK gilts and the Greek 2 year note – finally a slight bounce in the 'safe haven' (bwahahaha) yields, as to the Greek notes, oh well … – click for higher resolution.



5 year CDS on the 'Big Four' Australian banks  – the  up-to-their-eyeballs-in-mortgage-credit banking institutions down under are very much dependent on wholesale funding from overseas sources. Not surprisingly, the market is becoming increasingly concerned, although the absolute level of concern still compares favorably to that European and US banks currently are subject to. That could change of course – and we are watching these as an indirect indicator warning of potential setbacks in China as well, since Australia's economy is so intertwined with demand for commodities from China – click for higher resolution.



This chart is from the German IFO Institute and shows the development of euro area member nation bond yields since the euro's introduction was decided upon. The German legend that shows the three decisive periods reads: 1. 'exchange rates to the euro fixed' , 2. 'virtual euro introduced', 3. 'actual euro introduction' – click for higher resolution.




 Charts by:, Bloomberg





Emigrate While You Can... Learn More




Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA


Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • No results available

Support Acting Man

Austrian Theory and Investment


The Review Insider


Dog Blow

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts


Gold in USD:

[Most Recent Quotes from]



Gold in EUR:

[Most Recent Quotes from]



Silver in USD:

[Most Recent Quotes from]



Platinum in USD:

[Most Recent Quotes from]



USD - Index:

[Most Recent USD from]


Mish Talk

    Buy Silver Now!
    Buy Gold Now!