Coincident with our Monthly Theme call earlier today at 1pm eastern, the market began to sell off dramatically into the close. The primary piece of new information from the call was our expectation that Spain could miss numbers for GDP growth and deficit reduction. So while S&P’s conflicted head of sovereign analysis was hanging up the skates today and going into a new line of work, we were attempting to analyze this situation real-time.
The other noteworthy catalyst in Europe that occurred shortly after our call was that Germany is banning some forms of short selling related to shares of financial institutions and government bonds. Specifically, the German government is focused on naked short sellers relating to CDS on sovereign debt in Europe. The obvious question is: what will this do to the CDS market for European sovereign debt? That is, if the market is no longer two ways . . . will there be a market for CDS? And if there is no market for CDS, or ability for large institutions to buy insurance, will they buy European sovereign debt at the same prices or in the same amounts?
Take the market’s reaction for what it is -- the wrong type of regulation. Naked short sellers or CDS buyers don’t take markets down, fundamentals do. Or in this case, perhaps, fundamentally misaligned government-implemented market regulations do.
As we’ve outlined in the chart of the XLF (financial sector ETF) below, government-implemented short bans don’t end well. Or more aptly, they don’t provide the solution they are intended to solve for . . .On September 18th, 2008, the SEC implemented a short selling ban on certain financial stocks to “protect the integrity and quality of the securities market and strengthen investor confidence.”
It’s too bad there wasn’t a inverse ETF on SEC policies. The XLF peaked the next day at $22.38 and finally troughed on March 9, 2009, almost 6 months later, at $6.26, a decline of 72%.
I think more people than just Hank Paulson were throwing up on that ride.
Daryl G. Jones