The German Ban on Naked Shorts is Pointless Chest-Beating
The Germans took a swing at speculators late Tuesday night with their decision to ban naked short-selling in some financial instruments. Before long, it may look like one of those cartoon characters that aims for an opponent but hits himself instead.
Reading the headlines, you almost think that the Germans have made some sort of pre-emptive strike at pornographers or pimps: "naked short-selling" has to be one of the more amusing sexual, excuse me, financial practices. Customarily, short-sellers borrow an asset and then sell it, hoping to buy it back later at a lower price. It's a bet that the price will go down. Naked short-sellers have a fetish for selling the asset before they borrow it, if they do it at all. Kinky, huh? Specifically, the Germans have banned naked shorting of euro-denominated government bonds, credit-default swaps on those bonds, and 10 sexy German financial institutions, including Allianz and Deutsche Bank.
Now, in their hearts, the Germans have little sympathy with go-go financial capitalism. This is a country where manufacturing -- and fine manufacturing it is -- still plays an outsized role in the country's economy, and an even larger role in the public perception of what businesses ought to do. They ought to make things, and employ people at good wages while doing so. Every country has its own unique attitudes toward business and economics, and the Germans are entitled to theirs. And if you have ever listened to a German engine hum to life on a cold winter day, be thankful that Germans have their quirks.
And, to be fair, German politicians hardly have a monopoly on chest-beating but counterproductive measures taken against invisible foes who happen to be unpopular with the voting public. Angela Merkel, in a speech today, claimed the move will help defend the euro. But the Germans are making a concrete policy decision that fails on some very basic points -- points the Germans profess to care about in other circumstances:
1. Excepting the German financial institutions, trading in the other instruments barely exists in Germany. So why include them?
2. Then there is the matter of the euro. The Germans say they really care about the euro's stability, so listen up. Investors in a currency do not buy the currency itself but rather financial assets denominated in said currency. So if your regulator creates Sturm und Drang in your markets, you make those assets less attractive and depress the currency's value -- which is exactly what is happening today in markets. The Irish Economy blog, displaying that nation's characteristic wit, put it just right:
[P]erhaps 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.3. Are you going to even try to get some international momentum here? Truth is, there is a lot of sympathy in various Western capitals for restricting naked short-selling, which is hard to justify even as a corrective market mechanism. (For market discipline, you always have normal short selling.) Of course, if you come out guns-a-blazin', you will blow away the goodwill you might otherwise have enjoyed. Now, if you think folks outside Germany are more or less sympathetic to the German view today, raise your hand. Anyone? Marco Annunziata, the chief economist at UniCredit, one of Europe's major banks, outlined the damage done to the German cause in a research note:
First, and most important, it signals complete lack of coordination and even consultation within the eurozone. Today France quickly announced it would not follow Germany's decision, which it criticized as a potential risk to market liquidity. The eurozone still faces very difficult and politically demanding decisions, from the actual setting up of the EUR440bn Special Purpose Vehicle to a reform of the fiscal rules. Lack of coordination on similarly momentous issues of financial market regulation is extremely troubling, and can only undermine confidence further.4. Regulators are supposed to enjoy some limited autonomy from the ebb-and-flow of daily politics. They are not central banks, with statutory guarantees of independence, but common sense suggests they have some distance from political currents (and that industries they regulate, of course -- never forget that). It ensures long-term stability -- again, something Germans profess to like. So why embrace what looks like a quick political hit?
Much can change in hindsight. If the German move kicks off a worldwide push to clamp down on some of the financial instruments that do not serve the markets' core function of allocating capital to productive uses, then all the more power to them. But that is a game of global chess, and the German opening move looks rather clumsy.
Image from medienfrech via Flickr