Germany has imposed a nine-month ban on the sale of "naked" short sales in an effort to calm financial markets and slow speculators who bet on European governments defaulting on their loans.

The term "short sale" refers to a type of bet that that investors in financial markets make when they believe a stock or bond will fall. Essentially, they "borrow" a stock or bond and sell it, hoping it will drop in value and can be bought back for less. They pocket the difference and return the security to the original holder.

Some annoyed by German move

In a "naked" short sell, the seller makes the deal without ever having access to the stock or bond to begin with.

The German ban prohibits investors in the country from short-selling without proof that they have access to the underlying stocks or bonds to back up their deals. Germany's moratorium also applies to credit default swaps linked to eurozone governments.

European Union internal market chief Michel Barnier was slightly annoyed by the German move – not because of the decision per se but because France had not been consulted in advance. "The topic of naked short sales was not dealt with during the meeting of finance ministers on Tuesday," he said, adding that the EU should act as one to avoid confusion.

Unlike Barnier, European Commission President Jose Manuel Barroso held back on criticizing Germany. In fact, he urged other EU member states to follow Germany's lead in banning naked short-selling.

No common position

"Action by other national authorities, coordinated at the European level, would reinforce actions taken nationally and add value and weight to the message sent to the market," he said.

The problem is, EU member states have no common position on naked short-selling. The 2008 Lehmann Brothers bankruptcy resulted in a ban on the highly speculative practice, but it was dropped after a short time.

During a debate, European Parliament member Martin Schulz, said the eurozone's economic dilemma is largely due to a lack of coordination. "We have a variety of economic policies in Europe, which are not coordinated among EU member states," he said. "And very often, once national economic policy conflicts with that in another member state, even though we are working in a unified economic area."

Although France said it is not considering banning naked selling on European debt, it will continue its short-selling ban on shares of French financial institutions.

True remedy or symbolic act?

The Commission says it is examining the German ban closely and plans to outline its own proposals for regulation within the next few weeks. A key question is whether the ban will, indeed, calm financial markets or is just a symbolic act.

German Finance Minster Wolfgang Schaeuble says the time has come for action. "We have to move beyond the phase of making announcements and declarations of intent," he said at the Brussels meeting. "We need to execute. It needs to be clear that lawmakers set the rules – and not the markets."

Author: Peter Heilbrunner (jrb)
Editor: Ranjitha Balasubramanyam