Germany spooks markets with ban on naked short selling

World markets went through another tumultuous week, with risk aversion still pretty elevated amid lingering concerns that the euro-zone debt crisis will dent a global economic recovery. So, stocks were pummeled and commodities were pounded while the dollar and bonds were snapped up as investors continued to prefer safety and quality. But, the euro rebounded from a fresh four-month low against the US dollar by Friday amid talk of some intervention by the European Central Bank (ECB). A couple of weak economic reports on the US economy also led to the improvement in the euro-zone shared currency at the expense of the greenback. The euro also benefited from a flurry of short covering. At the same time, fear psychosis climbed with the CBOE volatility index or VIX spiking to a 14-month high of 46.37. The Wall Street's key fear gauge has soared from a three-year low hit four weeks ago as investors are increasingly turning skeptical about the efforts to rein in the sovereign-debt troubles in the 16-member bloc. Even at Thursday's highs, the VIX is still way below the peak level of almost 90 hit in October 2008 - after Lehman Brothers collapsed.

The European Union (EU) and the International Monetary Fund (IMF) have hammered out a nearly US$1 trillion bailout package for the debt-plagued euro-zone nations, but that has failed to assuage investor concerns so far. The ECB's announcement that it had made an initial purchase of €16.5bn (US$20.4bn) in government bonds as part of a programme to soothe markets had limited impact on markets. Sentiment across the globe took another big hit this week after Germany’s market regulator BaFin banned investors from naked short selling in 10 banks and insurers, as well as naked credit-default swaps (CDS) on euro-area government bonds. The regulator didn’t provide details on how it will enforce the ban or whether it would extend to trades outside Germany. Most CDS trading takes place in New York and London.

Germany will act alone where necessary, German Chancellor Angela Merkel said, referring to the short-selling ban by BaFin. "All of this will stay in effect until another solution has been found at the European level," she told the German parliament. The Netherlands and Finland said they have no plans to implement similar measures. France too doesn’t plan to follow Germany in banning the use of contracts to speculate on European sovereign debt, Finance Minister Christine Lagarde said. France has banned "naked short sales" on equity markets since September 2008.

Germany will lobby governments to introduce a tax on financial markets, and for ratings companies to come under European supervision so governments regain primacy over markets, Merkel said. The euro is at risk and Europe may be facing its greatest challenge since the founding of the EU, she said. The consequences are incalculable if leaders fail to act, Merkel said. Faster budget cuts, tougher penalties for euro-zone members that flout the rules and the orderly insolvency of euro-region states are among the measures Germany will put to EU partners on May 21, she said. "The lack of rules and limits can make behavior in financial markets driven purely by the profit motive destructive and lead to an existential threat to financial stability in Europe and even the world," Merkel told lawmakers in Berlin. "The market alone won’t correct these mistakes."

Separately, EU finance ministers gave their blessing to proposed regulations that would curtail the activities of hedge funds and private-equity firms. US Treasury Secretary Timothy F. Geithner will visit Germany and the UK next week to discuss the debt crisis in that region. EU President Herman Van Rompuy will host a meeting of finance ministers in Brussels on Friday to discuss reforms to economic governance. German Finance Minister Wolfgang Schaeuble will present a nine-point plan aimed at avoiding a repeat of the crisis touched off by Greece’s budget deficit. Germany is likely to approve its share of a US$1 trillion safety net for troubled euro-zone states and European finance ministers are meeting to discuss changes to budget rules to prevent another Greek-style debt crisis.