The futile battle of  European politicians against the markets continues

Governments and the banking cartels that are the true beneficiaries of the recent 'no bondholder left behind' bailouts in Europe continue their futile battle against the markets. The latest push to simply abolish portions of the market vividly demonstrates that they have completely lost the plot. Almost no surer way of destroying what little confidence remains could have been thought up.

 

Don't be fooled by the propaganda – they are trying to sell us their plans to ban trading in credit default swaps and ban short selling of certain financial stocks and government bonds issued by euro-area member states as a righteous 'strike against evil speculators'. This is nothing but a decoy, an excellent example of the Big Lie, designed to pull the wool over the eyes of the common man and distracting attention from those who are really responsible for the crisis – the very politicians who now try to shift the blame to speculators.

 

The following press release was issued by Germany's financial oversight bureaucracy BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht, Federal Financial Supervisory Authority) today:

 

“BaFin untersagt ungedeckte Leerverkäufe und ungedeckte CDS auf Staatsanleihen der Eurozone"

 

Translation:

 

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 an 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 regularly 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.

 

As Bill Fleckenstein (and others) aptly remarked: 'Germany shoots the messenger'.

 

I agree. Indeed, it is almost akin to a declaration of bankruptcy – a moral bankruptcy, an admission that the policies of debt and inflation have brought us to a juncture where politicians think that the only way they can still 'bring things under control' is by resorting to the banning of the trading activities of those who are most apt to express an opinion on their policies that truly counts – because it is expressed by putting money at risk.

That's not what it sounds like in the German media of course. TV stations are reporting on these latest attempt to distort the markets in a tone of approval, essentially parroting the line of politicians that the crisis is 'all the speculators' fault' and expressing relief that 'finally, hedge funds are put in shackles'.

Naturally, the idea that shorts can bring down securities that don't deserve to be brought down is utterly ludicrous. If that were true, we would have to ask, why didn't they buy CDS on Greek and Spanish bonds five years ago, or any other time than the present, for that matter? Why aren't the evil speculators doing this all the time, if it is so easy for them to bring a market down?

The answer is of course that short sellers cannot bring a market down at will. They do exactly the same thing longs do: they express their best judgment as to whether they think a given security is mis-priced. Given the high carry costs associated with the shorting of bonds and given the volatility in CDS, they take considerable risk when engaging in such trades.

If for example the fiscal house of the PIIGS were in good order, or even if the PIIGS could merely credibly communicate that it will be brought in good order in the foreseeable future, the shorts would immediately suffer large losses on their positions. So when short sales are banned, it is an admission that no such credible communication is likely or possible. It certainly tells us something about the credibility of the pledges politicians of the euro area have recently made. It says: 'don't take them seriously'. Meanwhile, the decision to include numerous financial stocks in the shorting ban is almost too stupid for words.

It is like saying : look! These are the companies that are in deep trouble! We've named them for you! This one is really a head-scratcher. Any owner of the stocks concerned that didn't immediately give a sell order is truly asleep at the switch.

As Darren Fox remarks in a Bloomberg report on the ban:

“The way it’s been announced is very irresponsible, and it’s sent many market participants into panic mode,” said Darren Fox, a regulator lawyer who advises hedge funds at Simmons & Simmons in London. “We thought regulators had learned their lessons from September 2008. Where is the market emergency that necessitates the introduction of an overnight ban?”

Where indeed? Has anyone given thought to what kind of message this is sending? It is essentially saying: more trouble is on the horizon.

 

 

Even more interference with the markets is now on the table

Parallel to these developments, another idea was pulled from the graveyard of 'nutty proposals that won't deliver what they should and aren't doable anyway'. This is the idea to institute a 'global transaction tax' on securities transactions. Luckily for the world, Europe can not possibly go it alone on this, as this would achieve nothing but killing the European exchanges – trading would simply move elsewhere. Note here that the capital funds and investors use in their trading activity is money that has been saved from income that has already been taxed many times over.

In addition, dividend and capital taxes are levied everywhere. Now yet another tax is supposed to be heaped on top of all this. We can only hope that cooler heads will prevail, but we wouldn't necessarily bet on it. In all likelihood this is seen as a cheap way to create additional distraction and score political points, as it seems highly unlikely that this baby will fly, but you never know.

 

From Market News:

 

BERLIN (MNI) – German Chancellor Angela Merkel said Tuesday that Germany will push for the introduction of a financial market transaction tax on the international level. "It is important that we come to an agreement on the international level," Merkel said after a meeting with Austrian Chancellor Werner Faymann here. Faymann echoed Merkel's remarks, saying it "is a question of justice" that financial markets contribute to the cost burden resulting from the crisis.

 

Faymann is a socialist and a walking, talking gift to stand-up comedians all over Austria, so the fact that he is in fervent support of this measure speaks almost for itself. I'm happy to report that Austria is so small most people have to squint to find it on a map, and consequently its chancellor is an international nobody (this is not meant to disparage Austria. Small is beautiful, and Austria has a lot going for it. Its politicians however are already a harmful enough species in their natural habitat, so letting them loose internationally doesn't sound like an especially good idea. Not that they are unique in this respect, far from it).

Merkel's coalition partner, the Free Democratic Party, has apparently relented after refusing to countenance the idea for many months – which is likely the  result of political calculation.

They probably feel fairly certain it won't fly, and by supporting it they hope to lose the taint of being the friends of 'evil banks and speculators' that has cost them dearly in a recent state election in Germany.

From a Business Week report on the same  topic we get this astonishing statement from an FDP representative in the German Bundestag:

 

“We agree that the financial sector must share in the cost of the crisis,” said Birgit Homburger, floor leader of Merkel’s Free Democratic coalition partner. “Those who speculate at the taxpayer’s expense must participate.”

 

This may be a good moment to remind Mrs. Homburger that the 'tax payers' were never asked if they agreed with the bailing out of banks and their bondholders. It was decided by politicians to reward failure and direct resources toward the propping up of unsound credit and investments. Furthermore, contrary to what she seems to believe or imply, the recipients of bail-out funds are not the only participants in the securities markets. Not a single hedge fund has asked to be 'bailed out' or received a single red cent in tax payer funds.

Only the highly regulated banking cartel, which due to a combination of utterly irresponsible central bank policies and a complete failure of regulators to enforce the existing rules, lost so much money that it went de facto bankrupt, has received tax payer-funded assistance – a decision that she and her fellow politicians made and supported, and no-one else (of course it also enjoyed the support of the recipients of the funds and their bondholders).

Among market participants we find inter alia pension funds, that are already in deep trouble due to the bursting of numerous speculative bubbles in recent years, and can hardly afford to see their returns reduced by a new transaction tax.

Guess who ends up paying for that – the very tax payers that are allegedly to be relieved by this new tax (the absurdity of the assertion that the lot of tax payers will somehow be improved by the introduction of a new tax should be obvious on the face of it).

 

 

What is really at stake

Declaring nebulously defined 'speculators' as public enemies as European politicians have recently done ad nauseam, should not blind us to what this is really about: governments and the banking cartels are arrayed on one side, and creators of wealth and tax payers on the other. Or, to quote Steven Saville: “In reality, it's the government and the banking industry versus individual freedom and the real economy.”

John Hussman publishes a weekly market report that I have the highest regard for and he has recently produced an excellent summary of the latest bail-out efforts and explains why, similar to the previous bail-out of the US banking industry, it is a really bad idea. If you have missed it, I encourage you to read 'Greek debt and Backward Induction'.

 

The essential points made can be summarized as follows:

  • there remains too much debt in the system that can not possibly be serviced.
  • by bailing out those who have proved the worst stewards of capital, we not only reward failure, but deprive the economy of all the investments that could have been made had this capital not been misdirected into ill-conceived bail-outs.

Hussman asks, rhetorically, 'What is so bad about letting bondholders take losses for risks they took voluntarily?' This is really a good question. We can assign a range of motives to the actions of policymakers, ranging from pure panic to attempting to prop up what is in fact an unworkable system on the grounds that it is very favorable for the establishment. In some cases economic ignorance surely played a large role as well – for instance, the stock argument that 'we must intervene, because if we didn't do it, things would be even worse' (an argument never put to a test) is probably believed by many.

The truth is of course the exact opposite – the myriad interventions over the years and decades have made the economy increasingly unstable, and as I have mentioned before, we must prepare for not only an increasing  amplitude, but also  a greater frequency of boom-bust cycles – for the simple reason that we have had too many credit-induced booms, which have likely done an enormous amount of cumulative structural damage to the economy.

As Mr. Hussman rightly points out, we can ill afford even more capital misallocation, whether in the US, Europe or China – and yet, this remains precisely the course politicians are firmly set upon. When observing get-togethers like G20 meetings and the like, one can not but notice that the true underlying problems at the root of the recent proliferation of crises are never mentioned, let alone discussed – this is no surprise, since the mere mention of the forever nameless elephants in the room (such as the fractionally reserved fiat money system) would throw the entire system and beloved status quo into doubt.

Politicians and bureaucrats naturally tend to think of themselves as essential features of civilized society without which we would sink into chaos, but an honest appraisal would find they are not only largely superfluous, but in fact are the main source of instability and chaos. Building on the capital our forebears have accumulated, liberal, free market oriented societies have achieved a an extremely high standard of living.

This happy state of affairs is increasingly endangered the longer we refuse to do what must be done: write off unsound debts, allow the failure of unsound investments, let the market allocate resources where they are best deployed, and fundamentally reform the unstable and unworkable centrally planned monetary system. All of these things require a vast reduction of the role of governments and the State in the economy – which of course is the major stumbling block to their implementation.

 

The market reaction

As Mish reminds us in his take on the shorting ban, whenever short selling restrictions have been introduced in the past, the market reaction tended to be the exact opposite of what regulators hoped for. For a very brief while forced short covering massively boosts the prices of the securities concerned, giving current holders of these securities a chance to get out at artificially inflated prices at the expense of the shorts, and then the securities concerned promptly resume their downward trek.

It's not as if that were a big secret, but Germany's bureaucrats seem unaware of the history of shorting bans, otherwise they may have thought twice about introducing one.

A ban on short selling was e.g. introduced in February of 1932 at the NYSE. As I have recounted before, Hoover hated the stock market, believing a conspiracy of bear traders was busy sabotaging his  efforts to achieve economic recovery. Not surprisingly, a ban on short selling had to occur to the authorities as a likely panacea at some point. If it was true that 'evil speculators' were behind the malaise, then why not just ban their trading activities?

The result probably surprised the meddlers quite a bit. The market bounced slightly for a grand total of about three weeks, and then collapsed by another 65% (it had already been down by 75% from the high of 1929 when the ban was introduced, I am referring to the additional losses incurred from the time of the ban) over the next 5 months. Ouch!


 

The February 1932 ban on short selling preceded the by far worst decline of the entire bear market – the market plunged by 65% over the ensuing five months. Not exactly what the regulators expected we can presume – click on chart for higher resolution.

 


 

Short selling restrictions were once again introduced in 2008 – leading to almost exactly the same outcome! The DJIA rallied by about 1,000 points in the two days after the restrictions came into effect with shorts frantically covering – and then it unceremoniously proceeded to crash.

 


 

The DJIA in 2008 – the two big white candles in the circle represent the initial reaction to the ban on short selling introduced at the time – a list of several hundred stocks became off-limits for short sales overnight, primarily the very stocks of financial companies most likely to fail. Two days of joy in regulator-land were followed by several weeks of regret as the market promptly crashed after the forced short covering was done. Investors meanwhile were deprived of an important tool to protect themselves against the collapse, which may have contributed to the crumbling of market confidence – click on chart for higher resolution.

 


 

We must await how markets in Europe take the short selling restrictions tomorrow, but in US trading on Tuesday one short term trend reversed concurrently with the announcement – while it is not certain if the announcement actually caused what happened with the euro, the fact remains that a small bounce reversed and gave way to more panic selling shortly after the news of the ban surfaced on the wires.

 


 

A small bounce in the euro is reversed in NY trading and another wave of heavy selling sends the currency out at almost the day's lows. Have the markets already 'voted with their feet'? It certainly appears possible – click on chart for higher resolution.

 


 

Gold reverses from an early sell-off as the euro crumbles – once again the metal fulfills its recent 'anti-euro' role – click on chart for higher resolution.

 


 

As can be seen, the short selling ban has immediately elicited skepticism – and rightly so. It appears highly likely that the German authorities (and any other European countries that may move to impose similar bans) are on the cusp of relearning what in the past has often proved a costly lesson. At least this time around they will find it more difficult to blame speculators – this is just about the only good thing likely to come from the ban. Perhaps the Germans should have spoken to former SEC chairman Brian Cox, who belatedly expressed regret over the short selling ban he introduced in 2008.

 

Said Cox:

 

However, Cox said he had some regrets over a drastic action the agency took as markets were hurtling downward in September. For a few weeks, the SEC stopped investors from making bearish bets on financial stocks like Morgan Stanley and Citigroup. The SEC's office of economic analysis is still evaluating data from the temporary ban on short-selling. Preliminary findings point to several unintended market consequences and side effects caused by the ban, he said.

"While the actual effects of this temporary action will not be fully understood for many more months, if not years, knowing what we know now, I believe on balance the commission would not do it again," Cox told Reuters in a telephone interview from the SEC's Los Angeles office late on Tuesday.

"The costs appear to outweigh the benefits."

 

Indeed.

 

Charts by: StockCharts.com, BigCharts.com, sentimenTrader.com.

 


 
 

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One Response to “Politicians vs. markets – part II”

  • Adolescent:

    Very good article!

    I am from small but beautiful Austria and I am one of only few Austrian Economics who live there.

    Most Austrians (like me) hate Werner Fayman, our chancellor because he is populistic, naive and simply hasn’t worked one time in his life. (apart from working for his party)

    I intend to leave my country towards a state with more economic freedom. Europe has only little future in my eyes…

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