Thursday, May 20, 2010

Lonely fighter or maverick?

The German ban of naked short-selling has caused new uncertainty in financial markets. It also met a lack of understanding from other Eurozone countries. The German solo attempt is a risky game.

What is good for Germany, is good for Europe. Since the start of the financial crisis, this very often seems to have been the guiding theme of the German government. However, remember the u-turns on bank guarantee schemes, economic stimulus packages and the approach to the Greek crisis? Initially against a coordinated European action, the German government often changed its mind, implemented national policies and confronted the rest of the Eurozone with a fait accompli. In the end, this strategy still led to good results but also to a lack of understanding from other Eurozone countries. Tuesday night’s decision to ban naked short selling seems to fit into this German strategy.

The German Ministry of Finance banned naked short-selling of sovereign bonds, CDS related to risks outside the Eurozone and the stocks of ten German financials. German Chancellor Merkel announced that the ban would remain in place until a common European solution has been found.

It still remains unclear what triggered this overnight decision. Did the German government have insider information which made the immediate ban indispensable? Was the German government dissatisfied with the European approach to tackle speculation and did it want to push other countries to do the same by presenting an accomplished fact? Or was it simply driven by domestic politics and the fading public support for the government? While all three explanations are plausible, the decision to ban naked short selling was in our view mainly driven by domestic politics. This view is supported by the fact that on Tuesday the German government also agreed on an international tax on financial markets. Details of this tax are still unknown and the ultimate success of such an international financial tax is also uncertain. However, it illustrates the government’s willingness to fight speculation, a policy topic which should find positive feed-back in the German public. Moreover, it undermines the German opposition’s attempts to gain political ground by proposing a financial transaction tax.

According to German Chancellor Merkel and Finance Minister Schäuble, the decision was needed to further stabilise financial markets. Recent measures had not been sufficient. Yesterday’s reactions in financial markets and comments from other Eurozone countries, however, showed that this goal had not been achieved. Markets dropped significantly and several Eurozone countries reacted with incomprehension. On substance, the German decision was welcomed. However, the timing and the solo attempt was less appreciated. Up to now, the German decision has left more uncertainties than clear facts. While the German government had somewhat slowed down the finalising of the €440bn Special Purpose Vehicle during the Eurogroup meeting on Monday, it now jumped the gun on financial market regulation. A clear line now looks different.

In the first stages of the current crisis, the Eurozone was affected by a global crisis. In these first stages, Germany’s more domestically oriented approach might not have been to the liking of everyone but it still delivered reasonable results. At the current juncture, however, the Eurozone is in the middle of a homemade sovereign crisis. In this situation, a coordinated European approach with a clear and strong commitment of all countries seems to be the only way out. In this context, the German solo attempt is a risky game as it creates new uncertainty in a just stabilising situation. To further stabilise financial markets, a clear line and commitment on the Special Purpose Vehicle and strong proposals for a new fiscal framework in the Eurozone might have been a better option than banning naked short selling.

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