Should Every Country Ban Naked Short Selling and Credit Default Swaps?


So far, German (PCX: EWG) Chancellor Angela Merkel has not been able to convince her European cousins to follow Germany’s lead in banning naked short selling and credit default swaps on European government bonds. But has German regulator BaFin done the right thing? Yes and no.

Naked Short Selling

Naked short selling doesn’t deserve a temporary ban … it needs to be banned from all global markets in order to restore confidence that Wall Street is not merely a gambling pit for the wealthy.

Naked short selling adds no value to market participants. In fact, the game of 3-Card Monte makes a complete mockery of investors. If governments can’t enforce their own rules to stop naked short sellers, Goldman Sachs (NYSE: GS) et al should financially engineer a process by which investors can naked buy stocks. That would put naked short sellers on the proverbial nudist colony.

Credit Default Swaps

Credit default swaps are another story. These separate instruments actually provide real value in markets the same way insurance provides real value to car owners. Moreover, allowing investors to use credit default swaps (or options) increases the number of people willing to either buy or hold securities. If the insurance wasn’t available, the only option would be selling or avoiding the security. That’s why you’ll see institutions dump European government bonds if they can buy insurance.


As usual, politicians are bundling a positive with a negative. So, the results will be far worse than if we actually had politicians who understood capital markets. But if other countries follow the naked short selling ban and ignore Germany’s judgment on credit default swaps, we may actually make markets more stable for future investors.

How will the sovereign debt crisis affect global markets? Click here to read our report for free in this month’s issue of Wall St. Cheat Sheet Premium.