By Paul Quintaro
On Thursday, after a meeting of European regulators failed to produce a definitive agreement, France opted to unilaterally enforce a ban on the short-sale of its financial stocks.
France was not the only country to enact such a ban—Belgium, Italy and Spain also imposed similar measures. However, France is most notable for a number of reasons.
France has the second largest economy in the eurozone in terms of GDP. It is also considered to be a key “core” member state—the others being Germany, Luxemburg, Belgium, and the Netherlands.
Until recently, speculation over troubled eurozone member states was confined to the PIIGS—the periphery nations.
Yet, within the last week, chatter has begun to circulate that France could be the next nation to come under fire. Shares of Societe Generale (OTC: SCGLY.PK), France’s second largest bank, plunged significantly over the last two weeks of trading, although it later rallied back following positive comments from the bank’s CEO.
While speculation may be overdone at this point, the decision to enforce a ban on short-selling may raise some red flags.
Short-sellers with significant buying power can force a stock lower, which may be a death blow for leveraged financials. Still, if the banks are truly on solid ground, why is it necessary to protect them from market speculation?
The investment bank Lehman Brothers famously collapsed during the 2008 financial crisis when it faced liquidity problems. However, prior to the bank’s collapse, the then CEO Richard Fuld began a concentrated attack on short-sellers.
Fuld alleged that there was a short-selling conspiracy which took down Bear Stearns. According to CNBC, he instructed his legal team to push information to regulators, perhaps in an effort to prevent an attack on his own bank.
Ultimately, history has shown that there were fundamental problems within Lehman Brothers, and across the broader financial system.
Are there similarities to be drawn with the current situation in France? In banning short-sales, are regulators simply putting off the date when investors realize that French banks face severe problems?
Further, speculation has risen that France itself could receive a sovereign downgrade. In its statement on the U.S. downgrade, Standard & Poor’s explicitly drew similarities between the debt levels in the U.S. and the debt levels in France.
Additionally, French banks also have tremendous exposure to the PIIGS, so any major defaults in that region could be felt throughout the French financial system.
On Wednesday, French President Nicolas Sarkozy cut short his vacation to return to France vowing to reform the French budget. Sarkozy promised to unveil a plan which would raise taxes and reduce spending.
Those plans may have to be shelved, however. On Friday, French second quarter GDP growth was announced to be zero percent. With France’s economy at a standstill, will it be possible to enact fiscal austerity?
Should France tumble, how will that affect the euro? As France is one of the key members of the eurozone, a financial shock in that country could send investors running for the exit, dumping their euro holdings for assets deemed safer.
Of course, as the euro has sold off significantly over the past several weeks, any evidence that the rumors of France’s demise are overblown could trigger a sharp rally.
At any rate, movements in the euro could increase in volatility in the coming days.
