Sounds like déjà vu all over again! Is Europe facing GFC Mark II?
The European Banks weathered the original GFC relatively well, but they are now having to come to terms with the issues resulting from the debilitating sovereign debt of the PIIGS economies (that is Portugal, Italy, Ireland, Greece and Spain).
The original Global Financial Crisis (GFC) was caused by the problems with subprime mortgages or exotic derivatives, and the eventual collapse of Lehman Brothers two years ago which triggered a systemic collapse of the financial services industry. The GFC required a coordinated global effort to ease monetary policy, with the US TARP bailout and interest rates at multi generational lows. It is worth noting that the markets took over three months to react to the bailouts.
The latest debt concerns have spread across Europe just as EU economies were returning to growth and banks were emerging from the worst financial crisis since the great depression. Europe is now experiencing severe volatility in their markets due to the their sovereign debt issues.
The market euphoria over the unprecedented emergency fund proposed by the European Central Bank (ECB) pledging $US1 trillion in EU aid was short lived. It has failed to bolster the euro or ease concerns over the doubts about the region’s finances. The current sell off in the Financial companies is being driven the concerns over the PIIGS economies and the banks’ holdings of bonds sold by European Union governments including Greece, Portugal and Spain, and the fact that at some point they will have to write down their exposure.
Germany has shaken investor confidence overnight with an announcement after market. Germany’s BaFin financial services regulator will temporarily banned on naked short selling and naked credit-default swaps of euro-area government bonds starting today. The ban also applies to naked short selling in shares of 10 banks and insurers that will last until March 31, 2011. BaFin cited the key reasons for the action as: “exceptional volatility” in euro-area bonds and “massive” short-selling leading to volatility extremes share prices moves which could if left unchecked undermine Euro-area financial system stability. They will prohibit trading in credit swaps on euro-area governments that are not used to hedge against losses in the event the government defaults.
Overnight the euro slid to a four-year low against the dollar around $1.22 after Germany announcement, fueling speculation that European debt crisis will worsen.
It is worth reviewing what happened to the markets when the US implemented its short selling bans back in September 2008 during the original GFC. As you can see in the chart the US markets fell another 30% before finding support.
This action by Germany will undermine investor confidence just when the financial institutions are at their most vulnerable, sparking concerns over erosion of the banks capital base and possibly another credit crunch. Do the German’s know of more bad news that is not currently in the market place?
By Michael Hevern
Head of Research
Tags: European Central Bank, Global Financial, PIIGS, short selling ban
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