Today was always going to be a significant day for Greece. For some time investors have had May 19th penciled and then inked into their diaries as a 8.6 billion Greek government bond issue matures today and needs refinancing. As we progressed out of winter and into spring there were ever more doubts about Greece’s ability to refinance herself because the yields on her government debt surged into double-digits. Even last night her ten-year government bond yield closed at 7.78% which is +5.01% compared with the equivalent ten-year German bund. So even after a rescue scheme which has been followed by a “shock and awe” plan and central bank buying of Greek government bonds we are left with yields which if sustained would lead to Greece eventually becoming insolvent.
However there is a happy ending for todays problem for Greece as she received 5.5 billion Euros from the International Monetary Fund on May 12th and has received this week some 14. 5 billion Euros from her fellow members of the euro zone.
A bonus for Germany and an implication for Greece
One impact of the latest stage of the crisis has been a flight to safety and quality by investors. One clear beneficiary of this has been Germany which has seen her bond yields reduce by around 1/3rd of a percentage point. Having followed them during this crisis I have seen them be very consistent in terms of ten-year government bond yields at around 3.1% but the current flight to quality has driven them down to 2.77%. Imagine explaining that to the Greeks! Her yields remain much lower at the shorter end of the yield spectrum (for example she has a bond with just under 5 years to maturity yielding 1.6%) so in terms of interest rate costs she will now make an even larger profit from her loan to Greece assuming the money is eventually repaid.
There is a further point which I have not seen aired much, Germany could afford to loan the money much more cheaply if she wished. If you think about it money at such a cost would make a big difference to Greece, let me give you an example as at an interest rate of 3% Germany could make a profit and Greece’s solvency prospects would be transformed. Germany could issue five year bonds at an interest rate of less than 2% to finance this so that she would still be making a profit assuming the bonds are repaid.
Germany bans naked short-selling of some shares and European government bonds
In a surprise move first hinted at by the Dow Jones news network, Germany at midnight last night banned naked short-selling of some shares and of European government bonds and contracts on them including credit-default swaps. I have to confess my first thought was how could this be applied to futures markets as I used to work in them and they allow you to go short or they cannot exist. There is a thriving futures market on German government bunds and there would be implications for it.
What is naked short-selling?
This is where you sell an instrument such as a share or bond when you do not own it. Ordinary short-selling is when you sell an instrument which you have borrowed from the owner of the instrument. Some years ago I took part in an operation where we bought warrants on Japanese shares and sold the stock, one of my colleagues job was to contact the various fund management companies and borrow the stock. In case you are wondering why they take part we paid them for the stock so they get an extra interest yield on the stock. The big investment companies hold many of these stocks and shares etc all the time and see the money as a bonus.
I would imagine that naked short-selling was probably quite rare actually as the majority of market professionals would have borrowed stock in the manner I have described above. So as a stand-alone move it is a curious one.
What was announced?
The Federal Financial Supervisory Authority has on Tuesday temporarily banned naked short sales of debt securities issued by euro zone 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 a euro zone country, and which does not serve to hedge against default risk (naked CDS).
In addition it banned naked short selling of various German companies Aareal Bank AG,Allianz SE,Commerzbank AG,Deutsche Bank AG, Deutsche Borse AG, Deutsche Postbank AG, Generali Deutschland Holding AG,Hannover Ruckversicherung AG, MLP AG, and Munchener Ruckversicherungs-Gesellschaft AG.
The German regulator BarFin justified its move on the following grounds.
1. The extraordinary volatility in debt securities issued by euro zone countries,
2. The use of credit default swaps on the credit default risk of several countries in the euro zone has increased significantly.
3. Massive short sales of the affected debt securities and the conclusion of naked credit default risk on euro zone countries had led to excessive price shifts and this had “threatened the stability of the entire financial system”.
This is an extraordinary move which came as something of a surprise but I have various thoughts on it.
1. There is an irony in the fact that for weeks and weeks I have argued for decisive action on important matters and when we get decisive action it is in fact on something which should be consulted about and implemented with consideration!
2. If you wished to know a list of German institutions who are in potential trouble in this crisis the German regulator BarFin has thoughtfully provided them for you. It looks like they have just flagged up a list of companies that have large and adverse bond exposures. Up until this point there was a least some doubt as to which companies were most in trouble.
3. When short-selling was banned in the UK it is my recollection that financial stocks still fell and if anything they fell even faster than before.
4. Germany is one of the fiscally most conservative and financially strong countries in the euro zone so it is unsettling that such a policy has started here. Is there something more disturbing in the back ground?
5. If I was a major shareholder in the companies listed I would be on the phone to the company board right now demanding clarity on the company’s bond holdings and solvency.
6. As someone who has worked in such markets there is another fly in the ointment of this plan. You see marketmakers in a security such as a government bond have to have the ability to go short of it. If you like it can be considered a unique privilege to them because of their unique circumstances. If German marketmakers in European government bonds cannot now do this then this idea may well reduce liquidity in the various government bond markets it was supposed to protect.
7. Everybody will be asking the question does BarFin know something that they do not?
8. There are a lot of consequences for the credit default swap market and the truth is that as I type this nobody seems to be sure what they are.
As the latest stage of the euro zone debt crisis was an increase in fear and uncertainty any move which increases fear and uncertainty should be avoided. However this is exactly what BarFin the German regulator has done. In football parlance it has scored an own-goal. It has mistaken a symptom of the crisis for a cause. In addition many will be wondering where this leaves euro zone solidarity….
Any doubt that one might have had about politicians not understanding financial markets has been pretty much been eliminated by this move. The initial impact of it was to unsettle the Euro exchange rate and American equity markets and this has now been followed by what I feel were predictable falls in European equity markets. Someone should have had the courage to say no, non or nein to this move.
It looks as though this move is likely to be copied by others as time goes by but the fundamental flaw is that one can often go offshore to do such things. Financial markets are very adaptable and flexible in such circumstances and if opportunities exist they will quickly take advantage of them.
There are a lot of news announcements by Chancellor Merkel this morning but one spoof one (thank you FT) has put a smile on my face “Merkel bans scoring against Germany at the world cup”.
I will update later on the ECB and the move by Italy to abandon mark to market pricing but wanted to get at least some views out punctually….
The moves chronicled above look more and more like something for the domestic audience in Germany. By this I mean that Chancellor Merkel obviously felt she had to be seen to be doing something before the vote on the European rescue scheme in the Bundestag. However there has not been a lot of European solidarity on this issue. Christine Lagarde the French Finance Minister has stated that she “regrets” Germany’s decision presumably because as the FT reported on the 29th March.
The French arm of LCH.Clearnet, Europe’s largest independent clearing house, will on Monday launch clearing of credit default swaps – a victory for French efforts to ensure the processing of such off-exchange derivatives instruments is done in Paris.
Just to highlight the confusion that she has found herself in the FT has again quoted from an interview she gave to the Radio station Europe 1 just a month before.
the CDS on sovereign debt have to be at least very, very regulated, rigorously regulated, limited or banned
I remember a programme from 20 or so years ago called “Soap” which used to start with the phrase “confused you will be..”
Italy suspends mark to market accounting for euro zone bonds
The Bank of Italy announced yesterday (Tuesday) that Italian lenders holding European government bonds in their available-for-sale portfolio don’t have to take into account possible capital gains or losses on them. This move was an attempt to safeguard capital ratios. In essence if you ignore losses then the capital ratios improve.
This is yet another example of the law of unintended consequences as it will achieve exactly the reverse of its objective. You see in a time of fear and uncertainty suspending the rules increases market uncertainty as confidence in the value of the (peripheral) government bond holdings and total exposures falls.This will have a knock-on effect on the share-prices of the banks it is supposed to affect.
Exactly like the German move above it has had the effect of declaring that there is a problem. Also as it is a move which is similar to one made by the United States in 2008 it also reminds us that the recovery since then may not have gone as far as we may have thought.
The European Central Bank,sterilisation and Quantitative Easing
Finally we got on Tuesday some fuller details on how the ECB is going to deal with it purchases of peripheral government debt. We also got an idea of how much it has bought so far as it bought 16.5 billion Euros worth in the earlier part of last week. This was a lower amount than some of the initial market rumours indicated.
In terms of sterilisation of the purchases whilst we got detail we also got a problem. The ECB announced that that it will sterilise its €16.5bn of bond purchases via the auction of one-week fixed-term deposits. Euro zone banks will be able to bid for the deposits, and they’ll be given to those that bid at the lowest yields. This seems clear enough but there is a sting in the tail as the ECB also announced that.
Fixed term deposits held with the Eurosystem are eligible as collateral for the Eurosystem’s credit operations.
You see the ECB is committed to regular tenders in its credit operations so in return for these deposits you have guessed it the banks can in effect reclaim liquidity as these LTROs have no limit. Oops.
So in effect we have a typr of Quantitative Easing and not full sterilisation from the ECB with this.