Two potentially MASSIVE things.

Two things happened today that may be related and together they could have truly seismic consequences.

This evening, with hardly any warning at all, the German Finance ministry said it was banning all CDS naked shorting and banning the naked shorting of 10 major banks.

The reaction of the market was first utter disbelief.

HOW are they going to define what was and wasn’t, how were they going to monitor and enforce, and how would Foreign exchange dealers unwind the a large chunk of the probably half a trillion short positions already in existence across Europe? Traders and commentators are already saying this is unworkable or frighteningly unwise. They think it could lead to a melt down. And there are signs that FX (Foreign Exchange) desks in Asia are already getting a massive volume of margin calls.

For those who don’t know short selling is borrowing shares with an agreement to return the shares on a specified date. The short seller then sells those shares. He does so because he is betting the share price will go down. If he is correct then when it does go down he can re-buy them at a lower price. He then returns the shares as agreed, and pockets the difference between the price he sold at and the lower price he repurchased them for.

Naked shorting just leaves out actually borrowing the shares. Which means you can place your bet on which way the price is going to go without actually having to get any shares at all. Without the shares you don’t actually risk any loss on the share price. You make a separate bet on their value. You can still lose on it. But you can also make vast amounts because you can make a bet on any number of shares you like – a huge number if you want. You don’t have to actually go and find people to borrow them from.

Critically, placing those bets feeds back into the real market for those shares. Lots of bets against a share price makes people think something is up, they sell and the price does go down. This is why people claim naked shorting speculatively drives prices down. And indeed it does. Big players can make a price go down by frightening the market.

OK.

Why would the German finance ministry do such a wild thing out of the blue with so little warning?

Well one easy reason is German bank shares are sliding. Commerzbank which I have long said was Germany’s RBS is down to 6 euros and looking like it could go light-out, soon. Other banks are getting shorted. But part of the reason for the shorting was the news of the short selling ban. Which makes the bank shares slide less a cause and more a consequence.

So what else?

Earlier today the US Senate passed the Cornyn Amendment of the Financial Regulatory Reform Bill.

If it were to become law the amendment would make it illegal for US tax payer money to be used to bail out countries whose debt exceeds their GDP. Greece, for example. Any such proposed bail-out would have to be scrutinised by the administration and the administration would have to certify to Congress and the people, that the debt can be and will be repaid. If it cannot certify this, then the US representative at the IMF would be instructed to vote against any such bail out and with-hold all US funds. The US is the largest shareholder in the IMF. So that would prevent any IMF help.

This amendment would, of course, have stopped the Greek bail out. It would not have happened and Greece would have defaulted leaving a smear of splattered French and German banks all over Paris and Frankfurt.

This amendment is not yet law. To become law it has to be reconciled with the House version of the Bill and then the President has to sign it. I doubt reconciling will be a problem. Will the President sign? If he doesn’t he and his party will get crucified at the Mid Term elections as the President who wants to throw US tax payer money at bankrupt, lying Europeans. So what do you think? WiIl he sign? Does it matter?

Even if this amendment does not make it into law, and I think there is a very good chance it WILL, the effect on the markets is already in flight and should hit the target in the morning with no warning at all.

It tells the markets there is every likelihood that the Senate, at least, has decided, that there will be no possibility of a bail out for Portugal, or Spain or Ireland or anybody who needs one. And certainly no further help for Greece. Which almost guarantees their default before too long. Incidentally this amendment would mean that in a little while the US itself would not be able to get an IMF loan.

Now what do you think the market reaction to such a notion might be vis a vis European debt? A good time to short a few insolvent nations and the banks who hold lots of their worthless debt? I think so.

I think the German Finance Ministry’s action banning CDS naked shorting IS the panic reaction.

If I am right then tomorrow could be a defining day, or at least the start of something defining. If I am wrong please feel free to laugh and poke fun.