If Alan Greenspan once famously chastised the financial markets for their "irrational exuberance", yesterday saw precisely the contrary, as global stocks collapsed once more, prompted by speculation and rumours. Six per cent in Paris. Five per cent in Frankfurt. Overall, European markets have now incurred 20 per cent losses in August.
The cause of yesterday’s collapse was rumours about one of the "three pillars" of the French banking industry, Société General, alleged to be in deep trouble due to its exposure to Greek bonds.
We’ll only know in retrospect if the rumours about Société Générale were true. Yet they caused frantic trading that pushed down the share price of the bank down over 14 per cent — with losses at one point of up to one fifth of the bank’s value. Other European banks’ exposure to the possible failure of the bank pushed the general market lower.
The falls in the French bank’s stock price were accompanied by speculation about the bank’s solvency, later retracted or left unconfirmed by those making the claims.
"Is Société Générale about to do a Lehman?" was the question posed on the Guardian’s world desk Twitter feed yesterday afternoon. Another tweeter, based in New York, asserted confidently "there’s a run on Société Générale. People are hitting ATMs. Game over."
Neither the newspaper nor the twitterer responded when asked by New Matilda whether they’d heard something we didn’t know about.
Indeed, the source they were relying on, the London Mail on Sunday, had not confirmed its original report. The paper reported on Sunday that in Britain, "a senior government source had described the position of … two banks [Société Générale and Italy’s UniCreditBank] as ‘perilous.’"
The Mail on Sunday asked neither of the two banks to comment about the claims in their story. And yesterday they issued a retraction, in which the paper conceded, "we now accept [the story]was not true and apologise to Société Generale".
But the retraction came too late for the markets. Banking is a confidence game: without confidence in an entity’s liquidity (in other words, its ability to pay out) shareholders will dump the stock and customers may even try to withdraw their savings as has happened in Greece this year.
Hence the seriousness of the crisis faced by Société Générale yesterday. For even if the rumours about the banks insolvency weren’t true yesterday morning, the reaction to them may mean they are borne out in the coming weeks.
Falls on stock markets will cause pain for many. Those with exposure to French banking stocks and their customers are biting their nails. Yet other investors are making big money on the Société Générale slump. As the BBC’s financial editor Robert Peston wrote yesterday "hedge-funds are having sport short selling French and European banks".
Peston is referring to the practice of short selling. Investors borrow securities, sell them to a third party, and then "buy back identical assets at a later date to return to the lender" in order to make a profit.
The principle behind short selling is simple: the seller gambles that they will return the assets to the lender at a lower price than they paid for them, pocketing the difference. Thus it is in their interest that the price of a given stock falls.
In recent weeks South Korea and Greece have again banned short selling, which was suspended across the world during the financial crisis in 2008, but has since been allowed again. (The Australian restrictions on the practice are regarded as particularly tough in the trade.)
Market reports from the past week say short sellers from the big hedge funds Brevan Howard, Man’s Group AHL and Winston have been again highly active in European banking stocks. One Reuters analysis reported last week that "funds have … made money shorting European bank stocks and betting against the debts of companies in sectors such as financials".
Another analysis from the news wire agency claimed that up to 6 per cent of BNP Paribas was now potentially out on loan to short sellers. That big French bank’s stock was caught up in the rumours around Société Générale, falling over 9 per cent on Wednesday.
So yesterday’s market sell-off — and the rumours that caused them — would have suited to a T the positions hedge funds were already taking.
Also benefiting are investors selling on French credit swaps, and the banks and other entities that are selling them. Credit defaults swaps insure against the risk that a state will go bankrupt.
French credit default swaps rose and rose over Wednesday’s European trade. Those holding US$10 million of French government debt must now pay $161,000 to insure themselves against a French government default. That makes insuring French debt more expensive than its Malaysian, Colombian or even Mexican equivalent.
Investors are speculating on French and Belgian swaps because the European Central Bank started buying Italian and Spanish treasury bonds on Monday. The ECB wanted to ensure Italy and Spain can continue to finance themselves on the markets, after markets decided they were a default risk over the past few weeks and pushed up the prices on their credit default swaps.
This wouldn’t be a problem for governments, if it weren’t for the fact that there’s a correspondence between what the swaps cost, and what states have pay as interest on their bonds to holders. So the higher the swaps go, the more likely it is that a state won’t be able to pay its debtors.
And so the speculation about a French and Belgian default kicked off just after the rumours about Italy and Spain’s ability to service their debts had died down. The French finance ministry and the big three American ratings agencies Standard & Poors, Moody’s and Fitch yesterday denied claims that France’s triple A credit rating was about to follow the United States down sunset lane.
August is summer holiday season in Europe, a time of traditionally low volumes on the markets. It’s a time when only a few large investors can easily force up or down markets.
That’s what makes yesterday’s large falls and the series of wild rumours that accompanied them all the more remarkable. The European financial regulators investigating what happened yesterday may have a big job ahead of them.
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