CONTRACTS FOR DIFFERENCE? SOLD SHORT?

CBOT Floor - Credit default Swaps (CDS) and Contracts for Differences (CFDs), similer to put options, are major tools of 'short-selling' generally (which depends on stock lending), are employed on a large-scale by hedge funds, but also by medium to small brokers, and by individuals speculators, and were at the heart of the relentless fall in bank shares especially in the two years after June 2007 when the bottom fell out of the markets followed by the credit bottoms falling out their trousered-economies.
CFDs are a leveraged way of participating in short-selling to profit from loss of market price in stocks, and as importantly, a way to profit from how short-sellers can cause stocks to fall in price! Many small sell-orders can drag a price down far more effectively than one much bigger sell-order. The blame for the credit crunch (that triggered an Anglo-Saxon recession by pricking the asset bubbles of credit-boom economies) is a long list that includes:
Sub-prime, self-certified, and buy-to-let mortgages sold to over-indebted borrowers;
Bugs in models of credit ratings agency that caused the models to be indifferent to defaults data and rate many Asset Backed Securities (ABS) far too highly;
Asset price weakness of Collateralized Debt Obligations (CDOs, also called ABS) when the bonds were offered into secondary markets that proved to be illiquid;
Credit Default Swaps (CDS) insurance-style derivatives on CDOs, and their further derivatives calls CDS Squared (CDSS);
Banks' inadequate levels of capital reserves, and their large 'funding gaps', which are banks' borrowings needed to fill the gaps between customer deposits and loans;
General accusations of weak regulation in an era of too-cheap money (low central bank discount rates);
Credit-boom economic growth policies in USA, UK and some other OECD countries such as Spain, Ireland, Greece, that also caused extreme imbalances in world trade;
Investor exuberance and blinkered risk-taking as property prices outpaced every other route to getting richer;
Extreme bias in bank lending in credit boom economies towards mortgages, property and consumer credit.
I could add other factors. But, surprisingly short selling, stock lending and CFDs have been treated as a tertiary symptom rather than also a major problem? A temporary ban was implemented on 'naked' short selling. This had limited effect because the rules totally misunderstood how short selling works to drag down stock prices. Note that short-selling and the equivalent of CFDs have been available for a century as a speculative way to profit iCFD short-selling, for example, was the lubricant for the German currency crash and hyper-inflation of 1923, and continued to be used in subsequent currency crises round the world - and in some minds especially in 1993 attack on sterling forcing it out of the EMS, called Black Wednesday. Shorting interest rates is well established.We see this again today in a sequence of sovereign debt crises and currency attacks. Traders are using every bit of political-economic news to perturb the markets, and sovereign debt is the current game of choice - why, because it can appear to the simple-minded to cover everything else in a national currency economy, which of course it does not really do so. Market regulators excuse call & put options, CFDs, in money market, bond and equities short selling as mostly legitimate risk hedging and also brokers need to maintain market liquidity by borrowing stock to sell when they are short of the stock, and so on. Hedge Funds and others have made $ billions of gains from asset price losses of longer term investors - one argument is that at least much of the value lost has been encashed and lost absolutely? The question is whether this is a source of sever systematic instability that should be checked. In defence of this lucrative activity, described by some as 'shooting turkeys in a barrel', various studies have been commissioned and published to show that profiting on the downside of markets is good, balancing, has little negative impact on prices, and is simply necessary! But, in crises when markets are volatile or obviously sliding, and when markets are nervous, easily moved by rumours and titbits of negative news, and when short term profit-takers out-weigh long term investors, then it becomes absurd to defend short selling or to assume that it is price-neutral or market-neutral!
At last there is some more determined action. A growing European consensus on the need for tougher regulation of CDS trading was reflected by Lord Turner, chairman of the UK FSA, who warned that naked trading in corporate CDSs could force companies into default. FSA has also said it is investigating stock lending - especially to identify where stock-owners have not been advised that there stock may be loaned out - to garner a fee for custodians - when the liklihood is that the stock will be returned worth less, like letting a hotel room to a rock band and getting it back trashed. A first-order problem is getting data on what's been going on for years and what is happening now?
Regulators in the US, Hong Kong and EU have outlined new reporting measures on short selling of equities while at same time trying to preserving liquidity benefits generated at the margin by short selling i.e. they seek to constrain the short term speculation. Europe and HK want more timely disclosure of short selling activity, America’s SEC is backing a rule that is resisted by traders who say it will detract from liquidity. The new rule seeks to block short selling if a stock falls at least 10% in one day. How that can practically operate is unclear. A Franco-German initiative, backed by Luxembourg and Greece, calls for regulators to be given “unlimited access” to a register of derivatives trading in order to identify who is trading and what they are doing. It proposes that derivatives transactions should only be allowed on exchanges, electronic platforms and through centralised clearing houses. Credit Default Swaps (CDSs) and CFDs are commonly used by banks and hedge funds to reduce their risk, but they are also popular with investors who buy and sell them with an eye to quick profit. Naked CDS and CFDs drove down Greek bonds this year and banks and financial companies last year, and the year before.
Lord Turner, who is also a member of the Financial Stability Board, which works on G20 global regulatory proposals. He wants regulators to look at the question of naked CDSs on both corporate and sovereign debt. “We need to think about whether we are being radical enough on credit default swaps . . . as to whether naked CDSs should be allowedd.” He is concerned that corporate CDSs can be easily manipulated to force a company into default, a form of market abuse. As before, however, hasty action is not advised! “We need to look at these issues very carefully. There is a danger of an oversimplistic belief that everything going on is shorting in the CDS market.”
Mario Draghi, chairman of the FSB, signalled this week that the group is focused on the issue. “This way of betting has systemic implications.The sense I have is that governments are increasingly uneasy with this. Whenever something has systemic implications, you can bet it is going to get systemic regulation.”