Probably the most significant financial news was when the German financial system regulators spooked stock, bond, commodity, and forex markets this week. They announced a ban on naked short selling of stocks and bonds of Germany’s 10 largest banks, German sovereign bonds – called Bunds, and credit default swaps on Bunds.
Short selling is where you borrow a security, then sell it with the plan to buy it back at a lower price later and return the borrowed stocks or bonds. A naked short sell is where you don’t borrow the security first. If the price of the security falls during the time in question, the trader makes money because they sold high then bought low – the same as by low then sell high – but with the timing reversed. Traders and investors sometimes short sell when they expect something to drop in value.
German regulators would have taken this move as a safeguard if they were concerned the value of German bank stocks and German Bunds were likely to lose value. That’s very interesting, because Germany’s balance sheet at the national level, as well as the balance sheet of businesses and households is better than most countries – certainly a lot healthier than the US and almost every European country.  That level of bench strength is what makes this such an interesting move.
German banking regulators acted alone in this announcement, in that it was not coordinated with similar moves from other European securities regulators.  The result was as expected:  global equities sold off and the Euro currency hit $1.21 – a 4 year low versus the US dollar.
There are many reasons why Germany may have done this. Here are four that come to mind:
1.   Since very few people are shorting German Bunds, Germany probably included the ban on shorting Bunds as subterfuge: cover for the real concern: German Bank stocks.  German banks have considerable exposure to sovereign bonds and corporate bonds from the PIIGS countries as well as eastern European countries. In fact, German banks have over $650B in exposure to the PIIGS countries alone. While it is true that German banks have a smaller exposure than France – and considerably smaller exposure in proportion to their economy -  the exposure is large enough that large write-downs on PIIGS debt would put large German Banks into an insolvent position.  Let’s face it, the latest $1T PIIGS bailout shifts a lot of that risk onto Germany’s balance sheet. German and French banks are going to be ground zero for losses when the PIIGS eventually default. Since no one else in the EU is going to protect German interests, German Politicians have to. Case in point: Angela Merkel -the German Chancellor  — went on the record on Wednesday saying the Euro currency is in danger of collapse. Markets are spooked because many are wondering what German bank regulators know that they don’t.
2.   Intent to damage the euro. Months ago, I suggested that Germany would welcome turmoil in Europe because it would devalue the Euro currency. This would be good for Germany so long as the turmoil is contained. The rationale being that Germany has done everything it can in order to grow their economy while remaining fiscally responsible. The missing ingredient is a de-valued euro currency. There’s nothing German fiscal policy can do to make that happen, and since monetary policy has been outsourced to the ECB, Germany needs extraneous events to drive the Euro lower. Don’t forget, Germany has been the world’s #2 exporter for many years -before dropping to the #3 position from China taking over the #2 spot . Germany relies on exports to drive its economy and was being badly hurt by an expensive euro. 42% of Germany’s economy is driven by exports whereas only 12% of the US economy is driven by exports. Hence, seeing the euro at par with the US dollar will help Germany tremendously. The most recent move by German bank regulators makes it harder to short German assets, but it points a big flashing arrow at the euro that screams “short me!”.
3.  On a related note to the previous point, it is no secret that France’s President – Nicolas Sarkozy threatened to leave the Eurozone in order to secure the $1T bailout from 2 weeks ago. If this latest move by Germany causes proportionately more grief for France and makes it appear as though Germany is in charge of her own destiny, that helps German politicians at home. Given that May 9th saw Angela Merkel lose an election in Germany’s most populous region, you have to know politics is somewhere at play here.
4.  The obvious:  I’ve been saying that Greece will have to default, and that it’s just a question of when.  If the rumors of Greece leaving the Euro are true -and I doubt they are right now– then Greece is also about to default on its debt. That alone, will cost German Banks $20B (at minimum) in losses on $40B in loans.