There has been a lot of talk about the recent German decision to put a ban on "naked" shorting on European debt, bonds and some shares of German banks. German officials came out and did it quickly.
Many are criticizing them for being anti free-market, singling out banks as bad guys and not being in with the rest of the euro zone in this decision.
However, at some point, a line must be drawn in the sand.
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I am basically a Libertarian. However, this credit default swap, or CDS, market is totally out of control. The world was fine without them. The problem is that they are flawed in concept. You can buy insurance on something you don’t own. Therefore, there is all the incentive in the world to collect this insurance.
The best analogy I have heard is that it is like buying fire insurance on your neighbor’s house. Once your neighbor goes on vacation, you will burn down their house so you can collect the insurance. With your own house, you have mortgage payments, down payments and a lot invested.
Therefore, when you get insurance on these bonds without actually owning them, you want them to default so you can get your money back. You will turn around and try to drive the price down to default-like levels.
Now don’t get me wrong — the problems with the PIIGS are their own. They have too much debt and bloated governments. However, the CDS vultures don’t help matters.
In addition, CDSs are traded off the market and only financial institutions really have access to them.
And it isn’t like the Germans are banning shorting — they are banning “naked” shorting, which is borrowing without actually putting up the stock on the buy side to go short. This is actually illegal on the U.S. stock market.
What I like about what the Germans did is that they didn’t try to talk to the banks (who of course will be against this).
They just did it.
It is time the rest of the world made such a move and imposed such a ban.
The financial markets are for buying and selling and speculating. They aren’t a casino, which the CDS market has helped them become.
I believe that the world should go one step further and get rid of the CDS market altogether. If you want insurance, buy the bonds and go to Lloyd’s of London and buy insurance on them.
We don’t need financial institutions burning down our houses.
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