ECB announces a negative interest rate

The ECB (European Central Bank) has set a negative interest rate.   As Time Value of Money math is still correct, this means that a euro today is worth less than a euro tomorrow.

Preventing bank runs in Cyprus

Cyprus is the latest Euro-zone country to be teetering on the brink of collapse.  A key problem facing regulators there is the threat of a bank run.   Briefly stated, a bank run can occur when the depositors of a bank all try and withdraw their funds at the same time.  In most cases, they choose to do this because there are concerns about the solvency of the bank.  However, the mere threat of a bank run can be enough to render a bank insolvent.

Which brings us back to Cyprus.   The linked video shows some of the lengths that Cypriot regulators are going to to try to prevent a bank run.




Bank runs are rare - although we saw one a few years ago in the UK.

Two on Europe...

A run on Greek banks - people are pulling out Euros.
and
Spanish bond yields continue to climb.

The Greek crisis explained using rubber ducks.

Felix Salmon uses rubber ducks, a paddling pool and a pirate ship to explain the problems in Greece.

Economists and their charts

A great article from the Beeb showing the favorite charts of various economists.  In each case the charts show how the euro economy in particular has declined.   Sounds a little dull, but this is a great way to see the Euro crisis in pictures.

Pigs will fly?

Investor cookbooks on PIGS.    (European countries that are at the heart of the debt crisis).

Ratings changes lag the market.

An important aspect of bond ratings is that when they are changed they usually lag the market.  In other words, investors usually price the declining credit quality of the bond into yields before the ratings agencies get around to issuing a new rating.  Case in point:  France.

Leverage...

Jon Stewart on MF Global, regulation and the effects of leverage.  (via Greg Mankiw's blog).

If there is one repeated lesson from virtually all financial disasters it is that it is not bad bets that are the problem, but the amount of leverage used to make those bets.

Reducing leverage would be the simplest way to prevent future financial disasters.  But, as the case of MF Global shows, even when there were limits to leverage, a well connected ex-regulator could circumvent them.

Short selling bans in Europe

This week, 4 eurozone countries announced a coordinated ban of short selling of some bank stocks.   This move is designed to stabilize prices and prevent "market manipulation".   In reality this is a bad policy.   The overwhelming evidence from careful academic research shows that short selling increases pricing efficiency and allows information about the true value of assets to be more rapidly incorporated into those asset prices.   If anything, eliminating short selling will increase volatility rather than reduce it.

There is an argument made that naked shorting (short selling without borrowing the stock) can have real economic effects, particularly when employed on financial stocks.  I think that this may have some merit in that if naked shorting could drive down a bank's stock price, that lower price might lead creditors of the bank to withdraw funding which might precipitate a bank run.   In reality, however, this is very unlikely because the total amount of naked shorting is tiny, as for most market participants it is illegal.

Naked shorting can be achieved by purchasing a credit default swap (CDS) however.   A CDS allows the holder to basically bet against the value of the debt issued by the underlying stock.  For a bank which is typically very highly levered, a CDS is really a tool for shorting the bank stock.   The "naked" feature of the CDS is that the holder doesn't have to actually hold the underlying debt of the bank.  Unsurprisingly, the eurozone regulators did not ban this type of shorting.

PIG spreads

A graph showing the yield spreads of the government bonds of 3 PIGs (Portugal, Ireland and Greece).
It's not pretty.  But it shows a fundamental premise of finance.  Ex-ante, you should get compensated for risk.

Source: The Economist

Germany expanding short sale ban?

Germany is thinking of expanding its short sale ban to include all stocks.

Personally, I don't think short sellers are the problem here.

Germany cracks down on shorting

Germany bans naked shorting. Rather than go after the root cause of the euro problem - they go after the hedge funds.

On a related note, my co-authors and I are just putting the finishing touches to a paper that shows that short sale restrictions in one country lead to more shorting elsewhere, and cause prices to deviate from fundamentals more often. Perhaps I'll send Merkel a copy.

A small data point in the euro crisis

Why do some euro zone countries have big deficits? Lots of reasons, but here's a new one... Italian senior government officials travel in a fleet of Maseratis.

How big is US exposure to the Euro crisis?

Maybe $54bn, but it is unlikely to get that bad. According to CNBC.