European CDS Short-Ban, European CDO Issuance, and Levering to the Hilt

Today feels like prison to any proponent of free markets.

To combat evil short-sellers, the European Union today banned short selling on sovereign credit default swaps. This follows an August decision to ban short-selling in select financial stocks of Belgium, France, Italy, and Spain. The result: Non-banned financial stocks in those countries dropped 4.4% through the end of September. Banned financial stocks dropped 10.4% over the same period — more than double that of those stocks that were NOT banned.

This latest decision to ban the short selling of sovereign CDSs most likely will produce similar results as is most always the case as studied by a 2009 report from the Centre for Economic Policy Research.

The other piece of unwelcoming news comes once again from Euro-land. The newly expanded â’¬440 billion European Financial Stability Facility will now be levered up to somewhere around â’¬1.5 to â’¬2 trillion through some creative derivative issuance on the pool of money. If you care to check the math on the calculations for the bailout and cross it with the probability of the now-lowered borrowing costs of namely Spain and Italy and come to the conclusion that it may very well need to be expanded to perhaps around â’¬3 trillion, I would suggest shorting the collateralized debt obligation used to lever the funds.

Oh, wait. That’s now illegal.

Risk management and hedging are essential elements to financial markets, particularly those as volatile as these. Despite governments’ and central planners’ logic, markets do not simply only go up.