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Germany, France urge EU-wide ban on 'naked' short-selling

By the CNN Wire Staff
  • Merkel, Sarkozy propose EU-wide ban on 'naked' short selling
  • Practice is controversial, artificially drives down stock prices
  • Germany banned the practice last month
  • Proposal aims to calm European markets

Berlin, Germany (CNN) -- German Chancellor Angela Merkel and French President Nicolas Sarkozy are proposing a Europe-wide prohibition of the controversial practice of "naked" short selling as a way to calm the markets, according to a joint letter addressed to the head of the European Commission.

"The severe turbulence observed on financial markets over recent months has ... led to considerable concern among member states of the European Union and all our fellow citizens," they wrote Tuesday to Commission President Jose Manuel Barroso.

They said such "high market volatility" raises questions about financial techniques including short-selling, in which institutions or traders bet that the price of an asset will go down. The sale becomes "naked" when the seller sells shares he doesn't own or hold, trusting that he will soon be able to buy them at a reduced price and "cover" himself that way.

Naked short-selling is controversial because it artificially drives a stock's price down to a level that doesn't reflect true supply and demand, said Sharyn O'Halloran, professor of political economy at Columbia University.

Germany banned naked short-selling on government debt and large financial firms last month as a way to stabilize what has been a very rocky bond market for Europe, as countries in the region try to finance their debt. The purpose was to make their financial markets more transparent and for prices to better reflect supply and demand, O'Halloran said.

"We believe that it is indispensable to reinforce the transparency of short positions on equities and bonds, especially sovereign bonds," Merkel and Sarkozy wrote. "The commission's work should encompass the possibility of an EU-wide prohibition of naked short selling of all or certain shares and sovereign bonds as well as of all or certain naked sovereign CDS (credit default swaps) and its conditions."

Throughout history, regulators have cracked down on short selling after a period of economic declines. In the United States, at the the height of the financial crisis in September 2008, the Securities and Exchange Commission temporarily banned investors from short-selling 799 financial companies.