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Thursday, 30 October 2014

Italy, Spain and the war on short-selling

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After four years of failure, Italy and Spain have opened yet another pointless front in Europe’s war against reality.

James Saft, Reuters Columnist

Spain and Italy both introduced short-selling bans on Monday, reacting to steep falls in their stock markets and as confidence slipped in their ability to repay their debts, prop up their banking systems and tend to their economies while remaining within the euro currency.

While only a fool could look on recent history and say that markets must always remain untrammelled, the instinctual urge to suppress reality by stopping investors from acting in their own perceived best interests is usually counterproductive.

It is also always a screaming sell signal, one that investors will put into action regardless of regulation.

Italy re-introduced a ban on short selling – bets that securities will fall in price – of financial stocks, this time for one week. Spain went further: banning for three months short selling for all Spanish shares, as well as index short bets, or any similar trade in derivatives on or off of established exchanges. 

While the ban helped Spanish and Italian shares to reverse earlier sharp losses, selling of government bonds continued as investors demanded a record rate of interest of 7.4% to hold Spanish 10-year debt. Italian 10-year bonds also fell, taking their yield to 6.38%.

“The problem is that there isn’t enough in the EFSF kitty to bail out the Spanish sovereign, its banks and its regions, and then have to deal with Italy. The breakup of the eurozone is no longer a taboo topic, even at the highest level at the EU and IMF”

Little wonder: both countries are in difficult straits, short-selling bans do nothing to change that, and, plainly, have a terrible track record for success.

Both countries are facing growing financing needs, made more complicated by a disturbingly incomplete picture of the borrowing needs of their regional governments and the stresses this will place on the European Financial Stability Facility.

“It’s called contagion,” economist David Rosenberg, of Gluskin, Sheff in Toronto wrote in a note to clients.

“The problem is that there isn’t enough in the EFSF kitty to bail out the Spanish sovereign, its banks and its regions, and then have to deal with Italy. The breakup of the eurozone is no longer a taboo topic, even at the highest level at the EU and IMF.”

A little history

Anyone with a memory or access to Google can easily find out exactly how successful these bans will be. A year ago in August, Italy, Spain as well as France and Belgium enacted short-selling restrictions as shares in their banking industries plunged. Patently Europe’s economy is now worse and its banking system remains intact only due to the grace and favour of liquidity from the ECB and pledges of official support and capital. Those shorting European shares a year ago were correct, both in analysis and in outcome.

Matters descended into farce in November when Carlo Giovanardi, at the time undersecretary in Silvio Berlusconi’s government in charge of family policy and drug prevention, laid the blame for volatility in Milan’s bourse on stimulant abuse by traders, a matter he thought might merit mandatory drug testing. The question of what drugs the traders were taking when bidding Italian banks up during the boom was not asked.

Or recall the US$1trn bailout the EU launched in May of 2011 claiming it would effectively curb “wolfpack behaviour” in financial markets. … The problem isn’t with the wolves, it is with the caribou.

And remember too that much of Europe, along with most of the rest of the developed world, slapped short-selling bans on their exchanges during the darkest days of the financial crisis in the last three months of 2008. Patently this did nothing to address the euro zone’s structural flaws, which weren’t even the focus of concern at that point.

A study by economists Alessandro Beber and Marco Pagano of short selling bans around the world during the 2007-09 period was damning.

They found that the bans hurt market liquidity, retarded price discovery and, with the possible exception of US financial shares, failed to support prices.

Short-selling bans are, and are perhaps intended to be, a side-show, an effort by officials with little else to offer to seem as if they are taking matters in hand. If Italy and Spain had genuine solutions to their banking and debt woes they clearly would not need to suppress price discovery.

A government which will ban short selling is one step closer to being one which may eventually think it has good reason to impose capital controls. That will be well understood and is a potent message for Italy and Spain to be sending.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

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