At VoxEU, Anne Sibert writes on “… how Icelandic banks issued “love letters” to each other – swapping their debt securities and using the other bank’s debt as collateral. This ruse ensnared not just the Icelandic Central Bank, but also the ECB – a fact that has only recently come to light. The ECB’s lack of transparency on this is a serious problem.”
The article is here.
Coming hot on the heels of the EU’s restriction on hedge funds because of the role they played in the financial crisis (though this role was in fact pretty minimal) comes the latest European attempt to deal with nasty financial market participants. The German government has released the following statement, translation thanks to the FT’s Alphaville column:
The Federal Financial Supervisory Authority has on Tuesday temporarily banned naked short sales of debt securities issued by eurozone countries for trading on domestic stock exchanges in the regulated market. It has also temporarily banned so-called credit default swaps (CDS) where the reference bond and liability are from a eurozone country, and which does not serve to hedge against default risk (naked CDS).
In addition, BaFin has banned naked short sales in the following financial sector companies:
AAREAL BANK AG
ALLIANZ SE
COMMERZBANK AG
DEUTSCHE BANK AG
DEUTSCHE BÖRSE AG
DEUTSCHE POSTBANK AG
GENERALI Deutschland HOLDING AG
HANNOVER RÜCKVERSICHERUNG AG
MLP AG
MÜNCHENER RÜCKVERSICHERUNGS-GESELLSCHAFT AG
These bans apply from 19 May 2010, 00:00, until 31 March 2011, 24:00, and will be reviewed.
BaFin justifies these steps given extraordinary volatility in debt securities issued by eurozone countries. Furthermore, credit default swaps on the credit default risk of several countries in the eurozone has increased significantly. Against this background, massive short sales of the affected debt securities and the conclusion of naked credit default risk on eurozone countries had led to excessive price shifts, which could have led to significant disadvantages for financial markets and have threatened the stability of the entire financial system.
Faced with these circumstances, BaFin has also banned naked short sales within the selected financial institutions.
The FT notes that “BaFin had previously introduced a ‘transparency system for net short selling positions‘, and found ‘no evidence of massive speculation against Greek bonds‘ in the CDS market.”
Let’s be clear about this. Short sellers are not the cause of the European sovereign debt crisis anymore than they were the cause of the Irish banking crisis.
As an aside, it’s worth noting that this announcement appears to have triggered a pretty serious downward run on the euro. Now I happen to think that this is a good thing in our current economic circumstances but perhaps the “ve must protect ze currency” crowd might remember that much of the demand for the currency comes from people who use it to purchase financial assets. If you keep mucking around with the rules of the games for financial assets denominated in euro, eventually investors pack it in and your currency loses value.
This shouldn’t be too complicated a point to understand. For example, I teach my undergraduates about how a currency’s value depends on the supply and demand for the assets denominated in that currency.
Anglo Chairman-designate Alan Dukes appeared on This Week on RTE Radio 1 yesterday. One aspect of the interview that worried me was Mr. Dukes’s comments on subordinated debt.
Morgan writes an overview of the Irish crisis at VOX: you can read it here.
I’ve written before about being in favour of a common EU-wide approach to financial regulation and crisis management. So, on the face of it, one might imagine that I’d be happy about the news that EU finance ministers are about to approve a proposal for EU-level regulation for Alternative Investment Fund Managers (AIFMs) including hedge funds and private equity firms. However, looking at the proposals, I’m not too positive about them.
I’m all in favour of registering these firms and collecting statistical information on the exposure that banks have to them. But EU the proposals seem to go well beyond this, including bans on selling to retail investors, limits on selling non-EU-domiciled funds inside the EU, the enforcement of capital requirements etc. I’m not sure that these proposals will ultimately do much other than encourage funds to set up outside the EU, for instance in Switzerland.
The documents associated with the proposal admit at various points that hedge funds did not cause the financial crisis. But other material says stuff like “the crisis has underlined the extent to which AIFM are vulnerable to a wide range of risks.” There seems to be an element here of trying to have it both ways. There is most likely also an element of being seen to do something by picking on an area that, as the BBC news story puts it “many say played a part in the global financial collapse” – even if what many say isn’t particularly accurate.