Naked short selling is a problem that’s currently on many people’s minds. To the annoyance of the other countries using the euro, Germany has banned this form of financial speculation, a sentiment echoed by the United States Secretary of the Treasury, who’s visiting Europe. The Dutch parliament would also like to ban it, but the Dutch government isn’t interested. And the investors don’t want their little toy taken away.

Naked short selling is nothing more than speculating with shares or bonds you don’t own. It works like this. A speculator expects the value of a share to fall. He sells a batch of shares he doesn’t own, waits until the value does drop, then buys them back an hour or a day later for a lower amount. He pockets the price difference, the profit, without having had to pay out a cent.

Imagine you allow your neighbour to use your house for two days because you’ll be away for the weekend. On Saturday, he sells your house for 500,000 euros. The housing market collapses, as expected, and he buys it back on Sunday for 450,000 euros. On Sunday evening, when you come home, you get the key to your house back, but your neighbour is 50,000 euros richer. If this happened in real life, you’d go straight to the police to press charges. But in the financial world it’s perfectly normal.

Little toy
Outside the world of politics, supporters of a ban in the Netherlands are difficult to find. Economist and journalist Mathijs Bouman, however, is an exception. He doesn’t reject a ban out of hand.

“I can well imagine that everyone in the financial world is saying: whatever you do, don’t ban it. It’s as if it’s a little toy about to be taken away from the financial boys playing in their sandpit. But I think you need to look at it from the other side. You have to ask yourself how bad a ban would be for society as a whole. For society in general, it’s not so terrible if these kinds of crazy gamblers can no longer take advantage of such opportunities.”

The biggest objection to naked short selling is that the speculator hoping for a fall in share values can manipulate the market. He can sell a huge batch of shares because it doesn’t cost him anything. Other investors grow nervous and also start selling, as a result of which the value does indeed drop and the speculator achieves his goal. A self-fulfilling prophecy.

Osama bin Laden
The method is as old as the stock exchange itself. In 1609, it was already banned when an Antwerp trader attempted to force down the value of shares in the Dutch East India Company. After the 9/11 attacks in 2001, Osama bin Laden was suspected of manipulating values by naked short selling shares in airline companies.

Naked short selling has been banned temporarily many times, but it also has a respectable use and is even indispensable, argues Rients Abma from Eumedion. He looks after the interests of, among others, Dutch pension funds and insurers and says it’s a method that works as a correction to stock market bubbles.

"Because short sellers speculate on fall. And if there’s an overreaction from people speculating on an increase, then short sellers ensure that the value gets pushed back down again.”

Starting a fire
During the Greek financial crisis the credit insurances, the so-called Credit Default Swaps (CDS) or short swaps, were the biggest villain. Those who buy Greek state obligations and, in effect, lend money to Athens, can insure themselves against the risk that the country goes bankrupt and can’t pay off its creditors.

But you can also carry out ‘naked’ dealings in these swaps, without even owning any of them. It’s comparable to someone taking out five fire insurance policies against their neighbour’s house. The temptation to set that house on fire can grow rather large.

It’s thought that large American banks such as Goldman Sachs deliberately speculated in this way on a Greek failure. They profited from their swaps, which in turn led to the value shooting up.

Second slump
To save Greece, a ban on this sort of speculation could be worthwhile, thinks Maarten Geels from asset manager Eureffect. But he says banning naked short selling to support the euro won’t make any difference.

“If you want to save the euro, you need another instrument. Because the reason why the euro has been so weak in the past few days is that people are scared the European economy is heading for a second slump.”

So it’s not the market that’s the real wrongdoer but, as Bill Clinton once said, “It’s the economy, stupid.”