Warning – this post is designed to annoy market fundamentalists and the naked short selling crowd…
The main argument against nationalising failing financial institutions at this point comes down to moral hazard.
This is a short post with the idea of turning that on its head.
Debt markets are currently illiquid and highly skittish.
It is alleged that short-sellers are causing problems – but if they are causing problems its not in the equity markets – its in the debt markets. Relatively small amounts of selling of debt can cause a very wide – and possibly self-fulfilling rise in the spread of some financial institutions.
And if financial institutions are going to be allowed to fail you can short their debt with impunity. Drive the credit spread up. The confidence collapse will make you a killing - at least according to Vanity Fair.
But thanks to Paulson et al you can’t do that any more.
AIG proves the government might make the bonds you shorted whole. Anyone shorting AIG debt just had their ass handed to them.
So if you short debt now – what you face is constructive uncertainty.
It might give the smarties some room for pause.