Professor Elam

Wednesday May 19 2010

A Credit Default Swap is an insurance policy against someone defaulting on a debt. But a real insurance policy requires that a person have insurable interest in the event, ie, I cannot buy a fire insurance policy on your house. However anyone can buy  a CDS on just about any default possibility, and so bond vigilantes have been doing this on Greek debt and German Banks. And so, Germany banned short selling in various shares. As markets around the world collapse, governments try to stop this by forbidding traders from selling short or selling shares they do not own betting on  further declines. The short term effect is that the shorts have buy back their positions, this bumps the market short term. But then the actual selling begins and the markets drop again. This is what happened to Fannie Mae in 2008, see below. 

As I write European markets are down about 2% this morning, American markets set to open down also. 

OIl is leading stocks down, the markets are seeing economic weakness ahead, the oil price is the black and red bars,the green line is the SPX. As you can see oil has now broken its 20 day Moving Average in blue, not a good sign.