How Greece was “shorted” in 2009
The term “short” refers to “naked short selling”, a special type of transaction that takes place in the secondary bond market. (The electronic platform where anybody can sell and purchase bonds at arbitrary, determined by “supply and demand”, prices.)
“Naked short selling” means that the bond seller makes an agreement to deliver bonds to the buyer a few days later, but the seller doesn’t need to possess the bonds on the day that the agreement is made. (Hence the term “naked”.) He can purchase the bonds anytime before the time that he must deliver them.
This provides a great opportunity to the seller: If the bond prices are declining fast enough, the seller can purchase the bonds a few days later, a little before the delivery, at a much lower price than the one that he agreed to sell them.
Here’s an example: The seller agrees to deliver to the buyer 100 bonds for 10 € per bond in 7 days. So the seller will get 100 x 10 € = 1,000 €. The seller doesn’t have the bonds at hand yet, but he sees that the bond prices are declining, so he decides to wait a little before buying them. He buys the bonds on the sixth day, when their price has fallen down to 8 € per bond. So he pays 8 € x 100 = 800 €. So the seller’s profit is 1000 € - 800 € = 200 €.
“Naked short selling” is considered a very dangerous practice as it can further decrease the price of already declining bonds by creating artificial supply of bonds. So Central Banks worldwide have imposed some limiting regulations against it.
For Greece, these regulations were:
- Penalties for failed transactions. (The seller fails to deliver the bonds.)
- A limit to the maximum amount of days that a naked short sale can extend to. Specifically for Greece this time limit was “T+3”, meaning that the delivery of the bonds could not happen later than 3 business days since the agreement date. This is a very effective regulation, since it usually takes more than 3 days for the bond prices to drop low enough for “naked short selling” to be profitable. So nobody will want to do it just for “making money fast”.
Until the Greek government-debt crisis of 2009, all these were normal and working as expected. Everyone was reassured that, if the greek bonds start to decline sometime, they will be protected by the Central Bank of Greece (BoG) from “naked short selling” attacks, that would further decrease their price.
However, in the autumn of 2009, when Greece was entering the crisis and its bonds started to rapidly decline, something very interesting happened.
At these dangerous times, when every “naked short seller” from around the globe was eager to exploit the decline of greek bonds and the only protection against it were the BoG regulations, the BoG made a very interesting desicion: It annulled all regulations! It abolished all penalties for failed transactions and increased the transaction time limit from 3 business days to 10! It was like an open invitation to every short seller in the world to exploit the decline of the greek bonds.
This lasted for about 5 months. On Thursday April 8 2010, the Bank of Greece reimposed the regulations. Estimated profits for “naked short sellers” during these 5 months reached tenths of billions of euros.
Sources:
In English:
https://www.greeknewsonline.com/papandreou-issues-stark-warning-to-politicians (Broken link.)
http://www.hri.org/news/greek/apeen/2010/10-05-20_1.apeen.html#02 (Broken link.)
https://legiongraeca.wordpress.com/2011/02/06/prelude-to-the-selling-out-of-the-greek-people/
In Greek:
http://deltio11.blogspot.com/2010/04/blog-post_7289.html
http://www.techiechan.com/?p=299
https://www.naftemporiki.gr/story/284195 (Broken link.)
https://www.capital.gr/forum/thread/1639032
https://legiongraeca.wordpress.com/2011/02/05/prelude-2-sale-of-greek-ppl/