Angela Merkel is right: the euro is in danger. The threat comes not from speculators, however, but from policymakers. The German government’s unilateral ban on naked short selling of eurozone sovereign bonds, either directly or using credit default swaps, is the equivalent of taking a wild swing at a straw man. It appears to be a politically timed move to win backing for the eurozone’s €750bn rescue package. The danger is that it saps confidence in that grand project. The ban was introduced without consultation with other eurozone governments, increasing the risk of regulatory discord when the opposite is needed. It reinforces the impression that Germany is seriously at odds with the financial markets.
Naked short selling is often a speculative trade. But it can also be a legitimate form of hedging, as when banks use it to protect their loan exposure to companies in troubled countries. There is a case for restricting it in illiquid securities, where shorting may manipulate or distort prices. But the €7,300bn eurozone government bond market requires no such protection. The International Monetary Fund estimates that investors’ net sovereign CDS exposure is only 0.5 per cent of total sovereign debt outstanding. Bafin, the German regulator, said on March 8 there was no evidence speculators using credit default swaps contributed to Greece’s woes. As a market, it is barely big enough to matter.
There is an urgent need to make markets more transparent and less prone to systemic shocks in light of the financial crisis. The proposal to route derivatives trading via clearing houses is sensible. There are consultations on a revision to existing derivatives market regulations. The unilateral German move must not detract from the wider effort to reduce opportunities for regulatory arbitrage. Germany has picked a battle it does not need to fight, against an opponent too small to merit its attentions. With friends like that, the euro doesn’t need enemies.