Tuesday, May 18, 2010

Is the Euro about to become a Peso? European Debt Crisis Intensifies...

It was another chaotic day on Wall St as stocks tumbled once again as concerns around the debt crisis in Europe continued to worsen.

The big news of the day was when Germany rocked the markets by announcing a ban on naked shorting selling of CDS swaps:

"BERLIN, May 18 (Reuters) - Germany plans to ban naked short-selling on stocks and euro government bonds, German all-news network N-TV reported on Tuesday.

German coalition sources told Reuters earlier that Finance Minister Wolfgang Schaeuble plans to ban short-selling from midnight.

Economy Minister Rainer Bruederele told Reuters that it was possible the short-selling ban would be quickly enacted.

No other details were immediately available."

Quick Take:

Germany basically just pulled the rug out from underneath the banks with this shocker. Essentially what the big banks were doing were shorting the sovereign debt of countries like Greece via CDS swaps.

The problem with these swaps is the lack of transparency.

Naked short selling via a CDS swap essentially turns the equity markets into a version of the "Wild Wild West" because you can basically short a countries sovereign debt via these swaps without providing any liquidity in return like you would shorting a stock on the NYSE.

There is no real liquidity in these CDS swap short positions because you don't provide any transparent collateral against the short position that you are taking in case you are wrong.

What makes short selling different in the stock market is you need to borrow the shares that you want to short in order to take a position against them. This provides liquidity to the market. Without providing any real liquidity you put the system at risk.

Just take a look at the 1000 point drop two weeks ago if you want to see an example of illiquid markets.

The CDS game needs to be done transparently or it needs to be eliminated. Without transparency its a blatant form of FRAUD. The scariest part of this derivatives system is the sheer size of the market: It's in the hundreds of trillions of dollars!

These CDS short positions on Sovereign debt are making Europe's problems much worse. They have forced the credit spreads of countries like Greece to soar which puts them at severe risk of default because their borrowing costs rise to the point where the government cannot afford to service the debt.

If this type of ganster "pile on" style investing is allowed to continue it poses a serious threat to the global economic system. We saw the damage these instruments can do during our own meltdown in 2008.

The Bottom Line

I applaud Germany and Europe for taking a stand against the banksters. This CDS ban goes into effect at midnight. The Euro is selling off hard after the announcement. It will be interesting to see how the market digests this tomorrow.

This move smells of panic which is why the reaction has been so negative early on IMO. I think the market is thinking that this change puts the banks in a world of hurt because they use these markets to hedge positions, and they are also a very profitable part of their business.

However, in the long run, this was the right thing to do because it is it goes along way towards cleaning up the fraudulent financial system.

It also could potentially take a lot of pressure off of the PIIGS in the long run. In the short run this could get ugly because the market will interpret this short banning move as being desperate.

The bottom line of all of these games is clear: The bankers need to be stopped, and the derivative game needs to be regulated before they blow us all to high heaven.

The bullish trend of the market appears to be toast at this juncture. The bulls keep trying to pretend Europe and it's problems will just "go away" and try and to take this market higher and they are starting to learn a painful lessson:

Time after time in the past few weeks the bulls are getting repeatedly buried as the "buy the dips" theory rapidly becomes an unprofitable one.

Once Wall St begins to understand the threat that the European debt crisis poses to worldwide economic growth could really force the market to unwind.

The sovereign debt contagion is much more of a risk to the financial system than the subprime debt crisis ever was IMO.

Now that Germany has pulled the trigger at a time when we are considering more regulations over here in the USA we have created a new risk:

Banking regulation! This will now become another worry for the markets and we all know how much the market hates uncertianty.

Unfortunately, I have many more fears other than just uncertianty:

If we refuse to follow in Germany's footsteps and stop the naked shorting of CDS then who is to say the bankers won't come over here and do the same thing to us here in the USA or Japan?

It's pretty obvious that Wall St doesn't care who they destroy if they can make a buck. They have already fleeced the taxpayers once with their games in 2008. I see no reason why they wouldn't fleece us again. The serious question is who becomes the next target?

Can you imagine what would happen to treasuries if the bankers and their financial weapons of mass destruction decide to target us next?

Be careful out there folks. This minefield is becoming increasingly dangerous. Enter at your own risk.

Disclosure: Sold 50% of my TBT position looking for better entry points as a result of the European debt crisis.


getyourselfconnected said...

Very good take. I am working mine up and will offer pure speculation as to the "why" this was done in such a hurry. What will happen next?

Jeffrey said...


My guess is someone was about to default.

It's a great question. Desperate times take desperate measures.

Futes getting killed by the way. -9 on the ES. Can't wait to see what happens when the European markets open up.

flipdippy said...

Hi gang.

What if the volcker rule also gets passed again this week?

Or is this yet another massive bear trap?

Stay tuned for next week's episode.

jeff said...


If it is they better start buying because the market is starting to think "sell in may and go away" like it usually does.

I think we move down onto the 900's with this correction. If things get outta hand on the way down then who knows?

Dow theorist richard russell was in a panic today telling his readers to sell every stock they own. He is usually a cool calm dude so I took notice. Richard has been doing his letter for over 50 years. Hearing him freak out today really spooked me.

CT-Hilltopper said...

I read the Russell piece.

I think things are moving faster than we had originally thought.

As for someone who was going to default...my money is on Greece.

jeff said...


Me too.

I thought we would see a correction but this could be something more. Although with the HFT's still in business anything is possible. I don't trust this market and I want no part of it. What's the point of going short if you cant find the liquidity to cash out. The no bid scenario is a very real one. I have a few short hedges on right now but taking a significant short in a market with no liquidity is risky. I read about traders holding options on the 1000 point dip that couldn't find anyone to sell to after the big move down. Cash will be king if this trend continues.

Anonymous said...

thanks for the clarification jeff; looks like a good thing, also why goldman sacks stock has been tanking lately, they knew this was coming?

jeff said...



No, I don't think any of the banks like GS knew this was coming so it hurt their stock prices.

Germany totally threw them for a loop. This will mainly effect only the larger banks like Goldman, MS, and JPM etc.

The CDS game is played by a privelaged few and this will be painful for them.

Avoid the financials here especially the TBTF banks like GS.