Category: European economy

Merkel Proposing Orderly Default Framework

Mrs Merkel has been speaking in the German parliament about her latest financial proposals. In addition to defending the CDS and short-selling proposals, the Germans are apparently preparing proposals for an “orderly insolvency of euro-region states”.  In a separate story this morning, I see that former Fed Governor Rick Mishkin has been reported as follows: 

“What they should have done was to let Greece go and say we are going to ringfence the rest of the system,” Mishkin said. “Ringfence the banks, protect the other countries that have problems such as Portugal, Italy and Spain, which have not been fiscally irresponsible the way the Greeks have been.”

It’s interesting to see how far the consensus has moved. We’ve gone from the idea that no Eurozone country can be let default and the IMF can’t possibly be allowed to help to getting ready for orderly defaults.

Germans Restrict CDS and Short Selling

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.

IMF Report on Greece

Jim Hamilton at Econbrowser points towards this IMF Staff Report on Greece released a couple of days ago. The report is pretty honest about the scale of the challenge facing Greece under the plan if it is to avoid default.

The New UK Government and Northern Ireland Corporation Tax

Northern Irish economists and politicians were delighted to have secured a commitment in the Conservative Party election manifesto (here) to “produce a government paper examining the mechanism for changing the corporation tax rate in Northern Ireland”.   There is cross-party agreement in the Assemby for adoption of the Republic’s 12.5% rate.  An interesting paper by the Northern Ireland Economic Reform Group (here) explores the legal issues, drawing heart from the European Court of Justice’s “Azores Judgement”.

Debt Profiles of At Risk Eurozone Countries

Here‘s an interesting set of charts from Spiegel Online describing the debt problems of the countries who make up a certain animal-related acronymn. The graphs on the maturity profiles of the debts for each country provide a useful perspective on the stabilisation deal.