By Anthony Faiola and Howard Schneider
Washington Post Staff Writer
Friday, May 21, 2010; A01
A German crackdown on financial speculators threw global markets into a tailspin Thursday, sparking the largest losses on Wall Street in a year, infuriating other European powers as they try to stabilize the ailing euro and raising questions about the ability of world leaders to coordinate their efforts at financial reform.
The measures announced unilaterally in Berlin earlier this week took U.S. and European officials by surprise, and they run counter to the broad pledges of cooperation that leaders of the world's top economies said would guide their overhaul of financial regulation. Instead of shoring up confidence in Europe's ability to address an array of economic problems, the actions -- including an outright ban on some types of aggressive stock trading -- seemed to backfire and spotlight divisions in the euro zone.
The fallout from Germany's actions hit Wall Street hard. Coupled with disappointing U.S. economic news, it forced the Dow Jones industrial average down 376 points, or 3.6 percent.
Germany, angry over pressure to bankroll its spendthrift neighbors, intends on Friday to press the 15 other countries that use the euro to follow its lead in setting strict caps on budget deficits to maintain fiscal order in the region. But the proposal faces significant opposition. And the tensions are highlighting the squabbling over the region's handling of the debt crisis, further eroding investors' confidence in the currency.
Still, German Chancellor Angela Merkel insisted in a speech that Germany is committed to its own path -- including stricter regulation of the speculative trading it thinks is damaging the euro and a new financial transaction tax that has lost favor in some other European countries and in the United States.
At stake is "more than a currency," Merkel told the German parliament on Wednesday, blaming speculators and high-spending neighbors for the euro's woes. "We are called on to preserve the European vision. If the euro fails, then Europe, too, will fail."
European officials appeared caught off guard, and they declined to follow. "It's important that member states act together," Michael Barnier, the E.U. commissioner for financial regulation, told reporters in Brussels. The French finance minister, Christine Lagarde, meanwhile, spent Thursday deflecting Merkel's suggestion that the euro is "in danger."
"I absolutely do not believe that the euro is in danger," Lagarde told France's RTL Radio.
German and French leaders later Thursday pledged to cooperate on financial reform and other issues. The worsening situation also led U.S. Treasury Secretary Timothy F. Geithner to alter his schedule and add stops in Britain and Germany to the end of his trip to China. Geithner is to meet with senior European officials to discuss the crisis.
The current tumult in the euro zone, which began as a crisis over Greek government debt but broadened to threaten larger financial problems, is a "potentially serious setback" that could undermine the health of banks and financial institutions and weaken economic recovery in the United States, Federal Reserve governor Daniel K. Tarullo said in congressional testimony on Thursday.
It also highlighted the gaps that world leaders must bridge as they try to craft financial regulations that can prevent another meltdown of the sort that occurred in 2008 without stifling markets. The steps announced in Germany -- a ban on what is known as naked short selling, and an intent to enact a financial transactions tax -- run counter to the direction preferred by U.S. policymakers and some other members of the Group of 20 economically influential nations.
A U.S. official familiar with the discussions said that there is still agreement within the G-20 about the basic principles of financial reform and that differences of opinion -- partly driven by the domestic politics in each of the countries involved -- are not irreconcilable. A U.S. financial reform package won Senate approval Thursday, and lawmakers say the bill could be sent to President Obama by July.
Merkel's comments in particular underscore Germany's sense that the euro is hurting because of investors' greed and foreign squandering, leaving the country's thrifty, hard-working constituents to pay the price. Merkel has spent important political capital trying to persuade skeptical lawmakers -- and an even more skeptical public -- to buy into a bailout fund for troubled nations that use the euro. Lawmakers in Berlin are set to vote Friday on the historic and highly unpopular measure, which would make German taxpayers the largest single contributors to a $1 trillion effort that will prop up near-bankrupt neighbors such as profligate Greece.
That price tag, German officials now say, has given them license to act on their own to safeguard the euro with new market restrictions.
The limits on naked short selling -- in which third-party traders can make money by placing bets on, for instance, how far a currency may fall, or just how close troubled countries such as Greece are to financial collapse -- is largely symbolic. Only a small percentage of such transactions are carried out in Germany, with most completed in London and New York, outside the reach of German regulators.
But as U.S. lawmakers debate their own, very different set of financial reforms, Germany's move has nevertheless frightened investors afraid of a global patchwork of regulations riddled with loopholes and anti-competitive barriers.
From an economic standpoint, analysts say, the curbs make little sense. Some, including Merkel, say speculative financial bets have exacerbated the troubles in countries such as Greece. But others say they have actually served as an early warning system, with a surge in negative bets alerting global markets that a nation's debt problems are reaching a tipping point. Without them, investors may be reluctant to dive back into the risky debt markets in hard-suffering European countries.
Germany's action may be temporary, in place until at least next March. But analysts say it sends a signal that Germany may move Europe toward radical financial reform that could distort global markets.
"If the effect of the ban was to protect the euro and the debt markets, it didn't do very well," said Michael Grote, professor of corporate finance at the Frankfurt School of Finance and Management. "It is absolutely not clear what the economic rationale behind this was."
Faiola reported from London; Schneider reported from Washington. Staff writer David Cho contributed to this report.