The Definitive Incomplete Analysis Of Today's German Shock And Awe

Tyler Durden's picture

As BaFin has yet to provide details of the naked short ban, here is the best "incomplete" analysis of today's events, written by BofA's Jeffrey Rosenberg.

Cleaning up the spill without stopping the leak

Today’s actions by the German Financial Regulator BaFin prohibiting naked short selling continues a long simmering approach to the European sovereign debt crisis that we believe mistakes financial market uncertainty for the cause of the crisis rather than its effect. Drawing an analogy to the other major headlines of the day, attempts to curtail the sovereign debt crisis through curtailing trading activity is like trying to clean up the Gulf oil spill without stopping the leak. Budget deficits are the leak in this analogy and are similarly extremely difficult to fix. By confusing the cause for the effect the policy response exacerbated rather thanameliorated market uncertainty and with concern over the loss of ability to hedge long positions, investors sold what they could with the declines in the Euro leading risk markets lower and US Treasuries higher in a flight to quality.

Creating confusion: the BaFin ban

Today, the BaFin announced a series of short-selling bans aimed at reducing financial system risk. The bans will begin at midnight tonight (18th-May) and last until 31 March 2011 (10.5 months). The ban will apply to naked short-selling of credit default swaps and Euro-area government bonds. In addition, the ban will apply to naked short-selling in shares of 10 German banks and insurers. The 10 names are: Allianz, Deutsche Bank, Commerzbank, Deutsche Boerse, Deutsche Postbank, Munich Re, Hannover Re, Generali Deutschland Holding, MLP and Aareal Bank.

So what does that mean?

We have more questions than answers at this point. First, naked short selling is well defined for cash markets – stocks and government bonds. It bans the selling of those when the seller can not deliver the asset to the buyer (within a proscribed period of time). These bans were put permanently in place for example in the US during the credit crisis. For CDS, “naked short-selling” is not well defined. There is no delivery of an underlying instrument in a short risk position in CDS (buying
protection), hence some other definition of what “naked” means for CDS will be required. How “naked” is defined could render market making difficult or impossible. Enforcement is unclear as well as the jurisdiction of trading to which the BaFin ban applies. That latter point could become moot were FSA and othernational regulators to follow suit with similar bans. Finally the scope of what “Euro area” debt means remains undefined.

And what does it mean for SovX?

Again, at this point we don’t know. Presumably as SovX underlying all reference Euro area government debt, whatever definition of “naked short” applies to CDS would also be applied to the SovX index. Should SovX gap tighter or wider? While the knee-jerk reaction to banning short selling may be to collapse short risk positions (leading to a gap tighter in spreads), the second thought is that having just banned naked short selling in CDS, the value of holding an instrument that provides short exposure to sovereign debt may increase. In the experience of the outright ban on shorting financials in the US for example, SEF (a short financial sector ETF) initially declined significantly, but ended up increasing in price far exceeding its levels before the ban was enacted.

Raising the risk of future restructuring

While today’s sovereign markets ended in Europe stronger on the heels of Greece securing EUR 14.5bn loan tranche (and before the ban headlines roiled the markets), the longer run performance of SovX and more broadly the pricing of periphery sovereign debt depends on the fundamental risk of restructuring and whether today’s actions to ban naked short selling appear to increase or decrease that risk. European policy makers’ strategy to stem the crisis is to buy Greece (and other periphery countries) time to implement fiscal tightening. Greece today delivered on the first round of that tightening, and the market response was positive. That illustrates the positive outcome of the intervention. However, markets remain skeptical as one quarter of austerity does not make a Spring – i.e. continued successful efforts will likely be required, and those will become harder over time as the economy contracts as a result of the implementation.

Because the cure can kill the patient

The market’s immediate response to the ban announcement was to sell the Euro. Such a response makes sense as when faced with the inability to manage risk in debt, stock or CDS markets, participants sell what they can. And that means the Euro. But by having inadvertently further undermined the Euro, today’s actions increase the risk of failure in the entirety of the liquidity support program as the Achilles heal of the European intervention is its potential to undermine the currency. Unlike the US policy response, massive liquidity support from the ECB can create the perception (if not the reality) of a debt monetization scheme. While the US explicitly monetized the debt, it benefited from a flight to quality and worlds reserve currency status, neither of which the Euro enjoys. A precipitous decline in the Euro remains the risk to the outlook, and on display today as the Euro declines led the selloff in broad risk markets.

Bringing back bad memories

Non-credit market investors learned the importance of the Libor – OIS spread during the US financial crisis. This of course is simply a modern version of the TED spread – a spread that measures the relative cost of private bank funding costs vs. government funding costs. These spreads continued to trade wider highlighting that the risk of a spread of Sovereign risk into the financials remains high. This occurs despite the decline from peaks in Sovereign CDS and government bond yields. Importantly however, since those markets now face the prospect of banning of naked short selling (CDS) and potentially an unlimited, price insensitive buyer (the ECB’s Securities Markets Programme for sovereign debt), those price signals likely no longer reflect market sentiment. Even in these short term funding markets, the reopening of the Fed’s dollar swap lines with the ECB limits to some extent the sentiment indication. However as the penalty rate for accessing dollar funding through the ECB (at 1%) still stands above the effective cost of borrowing dollars in the private market, the rise in Libor – OIS highlights continued fears of restructuring risk.

I fought the law...and the law of unintended consequences won

Count Bank of Italy’s decision to allow banks holding European government bonds in AFS portfolios to suspend mark to market accounting rules as the latest iteration of unintended consequences. By suspending the rules, inadvertently market uncertainty increases as confidence over the value of the holdings, exposures and hence capitalization erodes. That lack of confidence feeds directly into increasing short term funding costs that the widening in Libor – OIS highlights.

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RobotTrader's picture

They are U-turning the Euro and ES futures

Precious metals are getting sold in Asia.

Bonds and dollar backing off a hair.

Wanna bet we open green tomorrow??


living on the edge's picture

Perhaps this is all a head fake for a massive take down of Gold...

A Man without Qualities's picture

Maybe the Germans have asked for their gold back and the US is shitting itself as it has already sold it 10 times over?

Mr Lennon Hendrix's picture

You mean the gold that the NY Fed has loaned Germany?  Good luck with that, maybe London will give Hong Kong "their" gold too.  aha!

velobabe's picture

ok i give up,

let's go to the hamptons.

V as in victory.

fuckin, DUMPSTER bi....tch.

possible, your breasts are extraordinary

but not real†

fingerella, here†

anynonmous's picture

Count Bank of Italy’s decision to allow banks holding European government bonds in AFS portfolios to suspend mark to market accounting rules as the latest iteration of unintended consequences. By suspending the rules, inadvertently market uncertainty increases as confidence over the value of the holdings, exposures and hence capitalization erodes.


suspending mark to market certainly worked well in America - but hopefully it's different this time

No Hedge's picture is different this it always has regard vis-a-vis EU-USA measures...

guess what...the biggest debt isssue is not in is in US...and US guys are now making money with bets against same measures they have taken in order to bailout worked for them...but it will not work for EU

so, now we are getting picture that on relative basis US is better of  than, you can choose between 2 evils

I agree that EU officials should take more care about their economic policies than markets...had they done proper job in past, they would not have issues with markets now


maff's picture

doesn't europe want to devalue the euro anyway?

moneymutt's picture

Central planning has its problems...didn't Mao get everyone in China together to kill some pest bird only to have explosion of some insect (the bird ate) shortly thereafter...and why did they bring kudzu to Southern doubt a problem way less worse than an invasive species...

Thorny Xi's picture

Kudzu was brought from Japan by the wife of the then-president of the old Seaboard Coast Line railroad.  It wasn't so rampant in Japan and she thought it was pretty and might provide a way to control erosion along the railroad rights of way.

Mr Lennon Hendrix's picture

Poll:  Which currentsea will be the first to collapse?

a)  The Euro

b)  The Doelarr

c)  The Yen

d)  The Pound

I am going with the Pound, Yen, Doelarr, Euro to fall in that order and quickly.

mikla's picture

+1 (my choice exactly)

Busy-Body's picture

I have been known to answer to "fucktard", but, alas, twas not I.

Sudden Debt's picture


I bet half of this board go confused about that question :)

Mr Lennon Hendrix's picture

That was Ben Bernanke.  He who still has the songs "(Shorty what you drink) I Got Money in the Bank" by Lil Scrappy, and "It's All About the Benjamins" by Puff Daddy, and "A Milli" by Lil Wayne in his tape deck.  Buy a new mixtape BS! 

Paper burns, gold doesn't.  Get with it.

PS, That last 20 minute spike says silver is moving bullish again ;)

I think we sit at the bottom of this range until Europe loads up on precious metals.

Fuck yo couch Bernanke!

cossack55's picture

You forgot "Brother, can you spare a dime?' and my personal favorite " I'm in the Money" from Golden Girls of 1933 (actually written in 1922, catch the line about having the silver dollar back in the fold.)

No Hedge's picture

how about ABBA "Money, Money, Money"

and Pink Floyd "Money"

Sespian's picture

I have to go with the:

Yen (Japan has no real military and pre-emptive war is imminent with golbal currency collapse)




Is there a prize involved here?  I could use some good news.

moneymutt's picture

It's kinda of interesting that Europe is doing similar things to US but its all getting exposed immediately...fool me once...

buzlightening's picture

"Alles ist verboten!"  Mark to fantasy international accounting standards lead the world to WWIII!  3G history repeats as we blame Germany for WWI, II, & III; human misery, pain, & suffering!!!  Down goes the big red flag and dead head fed goons vaporized by Germany as history repeats!!  It's all 3D!  I can see clearly now!!

floydian slip's picture

I was just thinking along those lines.


Germany starts WW3!

then off to Pink Floyd...  would you like to see Britania rule again, my friend.

All you have to do is follow the WORMS!



cossack55's picture

Funny, the Kaiser, the Czar and the Queen were all cousins.  Now Uncle Ben the Terrible and the FinMins are all kissing cousins.  My, how history comes around and goes around.

gimli's picture

Dang -- it's getting confusing out there --

I need the help from some professionals:


Apostate's picture

Can you believe that Bloomberg is openly criticizing one of its most important clients? Strange times.

Matto's picture

The first paragraph says is all:

"May 19 (Bloomberg) -- Goldman Sachs Group Inc. racked up trading profits for itself every day last quarter. Clients who followed the firm’s investment advice fared far worse."

Goldman just cant seem to pick a winner at the moment,, oh wait they seemed to have faired ok themselves judging by their results..

hahaha!! what a bunch of putzes.

Double down's picture

Did not need to read the proof with Goldman I take a head line like that on faith.

jeff montanye's picture

the classic question: "where are the customers' yachts?"

MsCreant's picture

Gosh, if I was a client and I read that shit, particularly knowing how little they lose... well now. One day they will fuck over someone who has the power to do something about it. These court cases are a start but still.....



gimli's picture

You must understand. GS is just like a car wash. You pay 'em up front ...... and then you get cleaned out.

Yup ....... just like an Orc owned car wash ...........

Matto's picture

Exactly - taken to call them putzes now. Goldman is shitting in their own nest. Not long for them now.

DeweyLeon's picture

" program as the Achilles heal of the European intervention..."

Very a minor point but, heel.



Oh regional Indian's picture

I actually thought that was a funny, oxymoronic, Freudian typo.

Cleanclog's picture

When price discovery is manipulated or prevented, I don't want to play.  Watch as others "vote" with their resources.  And watch some of the "we have elite, inside access" get smashed.  

Real risk for even the insiders now.

buzlightening's picture

Your confused? Gia Moron, a spokeswoman for Goldman Sachs, declined to comment. 

Common sense folks just completely mocked by the dead head fed goons fleecing of America!! All these names thrown out are just a mockery from a place they get names for such a gullible crowd!! HELL!! 

QQQBall's picture


Gee a moron? Its not quite naming a boy Sue, but...

jeff montanye's picture

gia may be a moron but she's smart enough to dummy up when told to.  

buzzsaw99's picture

Is that a bazooka in herr pocket or are you just happy to see me?

Gordon_Gekko's picture

"For CDS, “naked short-selling” is not well defined. There is no delivery of an underlying instrument in a short risk position in CDS (buying protection), hence some other definition of what “naked” means for CDS will be required. How “naked” is defined could render market making difficult or impossible."

I, for one, won't be shedding any tears for CDS/CDS speculators. Good riddance, IMHO.

Matto's picture

I only hope Goldman had the major exposure.

Jesse prophecising that the CDSs wont be honoured anymore. FK YOU WALLSTREET!!

Sespian's picture

Ah...the ol' redefine the meaning of words game from the 90's.  A classic that never goes out of style:

SofaPapa's picture

Shock, yes.  But I'm not sure anyone is in awe over the destruction these morons are achieving.  Well... maybe in awe of how fast they are able to wreak destruction.  But was this really intentional?  The questions are flying fast and furious... I keep coming back to that old platitude about how "markets hate uncertainty".  Nothing if not appropriate here.

trav7777's picture

How are we to drive credit growth without the synthetic debt possibilities that CDSs bring?

beastie's picture

Do we have a yea or nay on how this effects commodities? Talking about gold specifically.