If you love your kids, stop the bond bonanzaInterest-Rates / Eurozone Debt Crisis Jun 04, 2012 - 01:12 AM GMT
A month and a half ago, I posed the following question in Spain, Land of Magical Financial Realism:
These days when I read about Spain I'm wondering more and more how and why it is that the country has any access at all left to international finance markets.
The essence of the article was that Spanish banks were/are buying Spanish sovereign bonds with money (well, money...) borrowed from the ECB, while the Spanish government in turn was/is propping up its banks with money with European Union funds. I quoted Yalman Onaran, who wrote this for Bloomberg at the time:
Holdings of Spanish government debt by lenders based in the country jumped 26 percent in two months, to 220 billion euros ($289 billion) at the end of January, data from Spain’s treasury show. Italian banks increased ownership of their nation’s sovereign bonds by 31 percent to 267 billion euros in the three months ended in February, according to Bank of Italy data.
"The more banks stop cross-border lending, the more the ECB steps in to do the financing," said Guntram Wolff, deputy director of Bruegel, a Brussels-based research institute. "So the exposure of the core countries to the periphery is shifting from the private to the public sector."
The jump in sovereign-debt holdings by Spanish and Italian banks has been fueled by the ECB’s 1 trillion-euro long-term refinancing operation, or LTRO, initiated in December, to provide liquidity to the region’s lenders. Encouraged by their governments to take the money and buy bonds, banks borrowed 489 billion euros on Dec. 21 and 530 billion euros on Feb. 29.
For lenders in so-called peripheral countries -- Spain, Portugal, Ireland, Greece and Italy -- profit also was an inducement: They could borrow at 1 percent to buy government bonds yielding between 6 percent and 13 percent.
Lenders in those five countries have taken about 715 billion euros from the ECB through emergency programs, including the LTRO, according to the most recent data provided by the central banks of those nations. Irish and Greek lenders have borrowed an additional 83 billion euros from their central banks, using collateral that isn’t accepted by the ECB.
My comment at the time:
Bank saves sovereign saves bank saves sovereign. Bank saves sovereign with ECB money, and sovereigns rescue their lenders with funds borrowed from the European Union. The Spanish zombie stalks the Madrid and Barcelona midnight streets bleeding German euro's. Magical realism at its best.
So, does Spain have any access to international bond markets? Thing is, perhaps it doesn't need it. Perhaps all it needs to do is follow the example of other countries, like the US, France and Germany, just to name a few, and unload its sovereign bonds on its own - often essentially bankrupt - banks.
Creative accounting knows no boundaries, apparently. And it will never cease to amaze me - that's how naive I really am - that people have gone about their daily lives for the past 5 years or so and accepted it all, this grand theft auto of accounting standards. What makes it amazing is that it's their wealth that is being used to enable the grand theft, and it's also their wealth that is being stolen. And nary a voice is raised.
We've had at least five solid years of a mass transfer of both wealth and risk, where the former moves one way, and the latter, the other way. Moreover, the sliding scales of creative accounting put a huge question mark behind the real meaning of the term "risk" when used in this sense.
When bankrupt banks, which can hide their being broke only through creative accounting measures and mass financial injections from public funds, buy up the sovereign debt of their own countries, which are also broke, "risk" is probably far too flattering a word to use. It's more like passing the hot turd potato around waiting for the right moment to dump it on your ignorant population.
Here's Jeff Cox at CNBC:
US and European regulators are essentially forcing banks to buy up their own government's debt—a move that could end up making the debt crisis even worse, a Citigroup analysis says.
Regulators are allowing banks to escape counting their country's debt against capital requirements and loosening other rules to create a steady market for government bonds, the study says.
While that helps governments issue more and more debt, the strategy could ultimately explode if the governments are unable to make the bond payments, leaving the banks with billions of toxic debt, says Citigroup strategist Hans Lorenzen.
"Captive bank demand can buy time and can help keep domestic yields low," Lorenzen wrote in an analysis for clients. "However, the distortions that build up over time can sow the seeds of an even bigger crisis, if the time bought isn't used very prudently."
"Specifically," Lorenzen adds, "having banks loaded up with domestic sovereign debt will only increase the domestic fallout if the sovereign ultimately reneges on its obligations." The banks, though, are caught in a "great repression" trap from which they cannot escape.
"When subjected to the mix of carrot and stick by policymakers...then everything else equal, we believe banks will keep buying," Lorenzen said.
Institutions both in the U.S. and abroad have been busy buying up their national sovereign debt for years, he found.
Spanish banks bought €90 billion worth while Italian firms picked up €86 billion just between November and March. Even in the UK, which has avoided a debt crisis as it is outside the euro zone and able to set its own monetary policy, banks have increased holdings of gilts by 100 billion pounds over the past few years.
And in the U.S., banks, though having "comparatively low holdings" of Treasurys, have bought $700 billion of American debt since 2008.
"Ask the simple question: Why are banks buying sovereign debt when yields are either near record lows, or perhaps more interestingly, when foreign investors are pulling out?" Lorenzen wrote.
He thinks he has the answer.
For one, the European Central Bank's Long-Term Refinance Operations provided guarantees for the debt, which Lorenzen deems a "heavily sweetened form of financial repression given the pressure banks were under" to buy.
"Banks have ended up buying bonds at yields where they would happily have sold them only a few months prior," he said.
Moreover, banks are allowed to not count the sovereign debt against their Basel capital requirements. Also, Lorenzen argued, European banks have escaped the onus of stress tests this year, a less-than-subtle hint that authorities are willing to tolerate a bit of looseness in banks so long as they are helping to stave off a full-blown debt crisis.
"One doesn’t have to be too cynical to hypothesize that all the disclosures on sovereign exposure have become a bit of a political liability at a point in time where the only buyers in size of periphery sovereign debt are periphery banks funded by the ECB," he said.
"As long as funding for sovereigns in markets remains in jeopardy, and as long as there is no clear move towards proper fiscal solidarity in Europe, we reckon there will be a strong political incentive to make banks captive buyers. That implies a move away from marking sovereign debt to market, away from raising risk weights, away from capital ratios that don't risk weight assets and away from stress tests incorporating government bonds."
For investors in bank bonds, the news is good — for now.
"As long as policy remains to sustain the status quo, bondholders should come out fine. Conversely, if the burden becomes too great, then the alternative will most probably involve a radical departure from current convention — to the detriment of bondholders," Lorenzen said.
"We suspect this binary outcome requires a political judgement that many funds are not particularly well placed to make." he added. "Instead of those economics, accounting and finance degrees perhaps you should have done political science after all."
Financial institutions all over the planet are allowed, nay, encouraged, to dump their lost wagers on the people who live on main street. And the people who work for them get paid huge salaries to do so. That's our reality. And apparently we've grown so accustomed to it we don't even question it anymore, no matter how bizarre it is however you look at it.
Which is strange, I say in my innocence. After all, this means that it is you, and your kids, who will be on the hook for banks' gambling losses. How does that square with anything you believe in, or anything you think your country and your society should stand for?
But wait a minute! Do not despair. Here's the cavalry....
Patrick Jenkins, Ralph Atkins and Miles Johnson report for the Financial Times:
A Spanish plan to recapitalise Bankia, the troubled lender, by indirectly tapping the European Central Bank for cash, was bluntly rejected as unacceptable by the ECB, European officials said.
News of the rejection came as Spain faces elevated borrowing costs in the bond markets, tries to persuade investors it can contain problems in a banking sector weighed down by €180bn of bad property loans and, on Tuesday, saw its central bank governor stand down early.
Madrid had floated the unorthodox idea over the weekend of recapitalising Bankia by injecting €19 billion of sovereign bonds into its parent company, which could then be swapped for cash at the ECB’s three-month refinancing window, avoiding the need to raise the money on bond markets.
The ECB told Madrid that a proper capital injection was needed for Bankia and its plans were in danger of breaching an EU ban on "monetary financing," or central bank funding of governments, according to two European officials. [..]
The government would like to see the ECB restart its government bond-buying programme and wants the nascent European Stability Mechanism to be retooled as a bank bailout fund. "This is like a game of poker now," one government adviser said, "and I don’t think Spain is bluffing."
Brussels has been frustrated with the Rajoy government’s handling of the crisis, a concern that dates back to an attempt last month unilaterally to sidestep EU-mandated deficit targets.
The latest bank recapitalisation plan has revived such concerns, with officials saying they had no forewarning about the scheme and that it undermined Spanish claims that they would be able to finance their banking sector on their own, either through the private market or Spanish government money.
But officials are also nervous that the row risks bringing to a head concerns over Spain’s creditworthiness, potentially shutting it out from capital markets. The ECB is determined to avoid a repeat of its bruising experiences handling Ireland’s banking crisis and has put pressure on Madrid to consult with it before deciding further steps.
That is absolutely brilliant. But it's not exactly the cavalry. The ECB tells Spain they can't prop up Bankia with sovereign bonds,. Or, well, they can, but only if the bank pays for the bonds with money borrowed from the ECB. Which it has no collateral for. Nor do most other Spanish banks. They have €180 billion in bad property loans, according to FT's guys. Or €270 billion in debt, according to other sources. Take your pick.
Still, the EU and ECB insist that Spain should come up with a solid recapitalization plan for Bankia (they should let it go broke instead). And its other banks. But Spain is broke, just like its banks. So here comes more cavalry, courtesy of Ambrose Evans-Pritchard, in a suggested subtle twist on Eurobonds:
Southern Europe’s debtor states must pledge their gold reserves and national treasure as collateral under a €2.3 trillion stabilisation plan gaining momentum in Germany.
The plan splits the public debts of EMU states. Anything up to the Maastricht limit of 60pc of GDP would remain sovereign. Anything over 60pc would be transfered gradually into the redemption fund. This would be covered by joint bonds.
Italy would switch €958bn, Germany €578bn, France €498bn, and so forth. The total was €2.326 trillion as of November but is rising fast as Europe’s slump corrupts debt dynamics. The sinking fund would slowly retire debt over twenty years, using designated tithes akin to Germany’s "Solidarity Surcharge".
In effect, Germany would share its credit card to slash debt costs for Italy, Spain and others. Yet it is the exact opposition of fiscal union. While eurobonds are a federalising catalyst, the fund would be temporary and self-extinguishing. "The fund is a return to the discipline of Maastricht with sovereign control over budgets," said Dr Benjamin Weigert, the Council of Experts’s general-secretary.
The ingenious design gets around the German constitutional court, which ruled in September that the budgetary powers of the Bundestag cannot be alienated to any EU body under the Basic Law -- the founding text of Germany’s vibrant post-War democracy.
The fund implies a big sacrifice for Germany. Its interest costs on joint debt would be much higher than today’s safe-haven rate of 1.37pc on 10-year Bunds. Jefferies Fixed Income says it would cost 0.6pc of German GDP annually. The Council of Experts -- or 'Five Wise Men’ -- argue that this would be modest compared to the growth adrenaline of resuscitating monetary union.
Yet it is not charity either. One official said a key motive is to relieve the European Central Bank of its duties as chief fire-fighter. "We have got to get the ECB out of the game of distributing money, and separate fiscal and monetary policy. Germany has only two votes on the ECB Council and has no way to control consolidation," he said.
Look, there will be a zillion more of these plans, count on it, and if one proves unacceptable to one country or the other, there'll be another one the next week, but none of them can solve what underlies the foundation of the issue: Debt. Capital D. Which must be serviced. Which must be deflated.
And which won't just magically vanish if we "decide" to have growth again and spend ourselves into more debt in order to achieve that. Growth is not something you "decide", it's something you work for. And even that will only work AFTER you pay off your debt, once that debt has crossed a critical mass limit. We're way past that limit.
The one and only question that has yet to be answered, though we're getting there fast as long as we leave the financial industry holding the reins of our societies, is who will pay the piper. The way things have gone so far, it’ll be your kids. You might want to think about that one a bit more than you have so far. If you really love them, that is. In that case, you can take some of the pain upon yourself, so they will have less of it in the future
If only because the danger to your kids doesn't stop with your governments stuffing you - and them - with your banks' debt when you weren't looking. It's way worse than that.
The government debt that you and your children are now increasingly and directly responsible for, underwrites, collateralizes, give it a name, something far greater and more menacing.
If the debt, the transfer of it, the injustice, and the grand theft auto of it all, has still not been enough for you, maybe the following will make you think twice, thrice, four times.
The damage will be devastating. To your children. Here's Tyler Durden quoting Raoul Pal, founder of Global Macro Investor, in "The End Game: 2012 And 2013 Will Usher In The End"
The problem is not Government debt per se. The real problem is that the $70 trillion in G10 debt is the collateral for $700 trillion in derivatives…
Spot on. And we don't stop this, pretty soon all private debt will become public debt, squashing your children's future like a steamroller. Your call. And if you're in the US and you think this is a European issue, think again. Sure, you're the best looking horse. True. You look just dandy. In the glue factory.
By Raul Ilargi Meijer
Website: http://theautomaticearth.com (provides unique analysis of economics, finance, politics and social dynamics in the context of Complexity Theory)
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