Angela Merkel's mistake: Battling the financial markets

Saturday, May 22, 2010

WE UNDERSTAND that the bailout of Greece and other Southern European fiscal miscreants is unpopular in Germany, whose taxpayers will shoulder much of the cost. We further understand that Angela Merkel, the German chancellor, had to appease public opinion to win approval for the bailout in Germany's parliament. Still, her government's sudden and unilateral ban on "naked" credit default swaps this week was not the way to do it. It was so transparently political and, in policy terms, so irrational that it raised doubts about Berlin's leadership in the euro crisis. Whatever short-term domestic political benefits it had were offset by the damage it caused, and may yet cause, on financial markets across the world.

Naked credit default swaps enable speculators to bet on the future value of financial instruments they do not own. Ms. Merkel blames such betting for the troubles of European sovereign debt. She sees "a battle of the politicians against the markets" that she is "determined to win." Gripped by this mentality, Ms. Merkel ignores the fact that Berlin's own financial regulatory agency announced on March 31 that "the market data . . . do not support the conclusion that speculation is taking place on a massive scale."

And she seemingly does not fathom that naked credit default swaps can provide an early warning system -- in the absence of which profligate entities, such as Greece's government, may be enabled to extend their profligacy. In that respect, speculators are not fiscally hawkish Germany's "adversaries," as Ms. Merkel says, but its friends. It was especially strange that her government also banned naked short-selling of shares in Germany's largest banks, which are heavily exposed to Southern Europe's sovereign debt. That can only make investors more suspicious of those ostensibly sound institutions.

Ms. Merkel needs to remind herself that "markets" are mostly made up of money managers doing their best to protect pension funds and other savings of ordinary people. She says that she is trying to rescue the euro, but excessive rhetoric stimulates a flight by investors to other currencies. She says she is trying to save Europe, but erratic action feeds the impression of a continental political class that may be losing its nerve and its way.

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