Wall Street’s weekend LTRO conversation: Stealth sovereign bailouts

Daily Collateral's picture

Analysts are questioning the "double-down effect" the ECB's LTRO exercises are creating in eurozone sovereign spreads. Citi notes a spike in the purchase of government securities since the initial take-up in December:

Perhaps more striking is this chart, which shows rising proportions of sovereign securities to total assets in the banks of peripheral countries that have been most prone to interest rate shocks over the last few years:

Sure, it might seem counterintuitive to gobble up the very sovereign debt representing such an existential threat to one's own capital base, but when one examines the effects that the LTROs have had on eurozone sovereign yields, it seems reasonable to assume that is the ECB's plan and we will just have to live with it. As Citi puts it:

As the EBA announced in February, that the next stress test will be in 2013, periphery country banks have the blessing of European regulators (and probably the active encouragement of their national regulators and other national authorities) to expand their holdings of domestic securities, and specifically domestic sovereign debt.

Jefferies chimes in Sunday evening with a brief history of modern financial repression, following on the same threads that Dylan Grice and Credit Suisse strategists explored last week. Did you know, for example, that between 1945 and 1980, there was only a single year when Argentina saw anything other than negative real interest rates? Jefferies summarizes a piece of academic research put out by the Bank for International Settlements in November 2011:

It appears that individuals forget that financial repression has been used far more frequently in the past, particularly in liquidating the vast debt accumulated by developed countries post the Second World War. Indeed, in the past, the US and UK have seen their debt ‘liquidated’ using negative real interest rates by 2% to 3% of GDP on average per annum. The US and UK did not use high levels of inflation to do so in comparison to other countries. Argentina holds the record with negative real interest rates recorded every single year but one between 1945 and 1980.

Secondly, the inflation rate may not necessarily need to neither be that high relative to history nor take markets by surprise. According to the authors, between 1945 and 1980, the average US and UK negative real interest rate was 3.5%. However, the average for Argentina between 1942 and 1980 was 21.4%.

What should be recognized here is that, irrespective of one's opinion on inflation prospects, one ought to consider the possibility that, if a central banker believes it can be done, a central banker will probably try to do it -- in fact, the decision might even be credibly backed by a study done by none other than the central bank of central banks, the BIS.

Here is what the process has typically looked like the past:

So, with the negative real-rate outlook as a backdrop, Jefferies finds the proper words to elucidate its views on last week's LTRO:

The ECB’s LTRO can be thought of as ‘a shadow QE’, in which the domestic banks support the ‘financial repression’ of their respective government debt. In effect, they have doubled down on their own government debt to rescue the country and at the same time themselves. Low nominal yields keep the governments solvent while the banks can earn a healthy spread between borrowing at 1% and owning government debt at more than triple that over a three year period. The scheme can work as long as the government does not default.

Morgan Stanley is running with the same theme on Sunday with a brief remark on LTRO, echoing the comments above:

With banks incentivised by the cheap loans and encouraged by their regulators and governments to load up on the bonds of their sovereigns again, they are actually becoming more vulnerable to the next sovereign crisis. Recall that the ECB’s version of QE, which we call indirect QE, differs from other central banks’ QE in an important way: there is no transfer of sovereign risk from the private sector to the central bank. Rather, the risk remains on banks’ balance sheets.

As noted earlier, the elevated dispersion in LIBOR rates could be indicative of data that doesn't jibe with the official story on post-LTRO sentiment in the European financial system. Soc Gen, however, thinks LTRO has provided more than enough liquidity to address funding stress:

The result from this exercise, which is more important than the actual number, is the fact that banks have taken up as much funds they believe they need. And that should ease any concerns about funding (banks face €320bn of redemptions in senior unsecured and government guaranteed bonds this year) or liquidity issues. Furthermore, it is likely that banks will look to use the funds for carry trades and the front-end financials look likely to benefit as was the case in December/January.

Indeed, there is a lot of buzz over the potential for carry profit the ECB has introduced with their LTRO programs. Here's a great example of a winning carry trade, courtesy of Citi:

Individual bank reports suggest that non-euro banking groups too used their euro area branches to tap the 3Y LTRO in February more than they did in December. If there was a large demand by foreign banking groups, and if the liquidity obtained in the LTROs by their euro area subsidiaries was channeled outside the euro area (and possibly swapped into other currencies), this would clearly undermine the stimulus of the 3Y LTRO for euro area companies and households.

However, the LTRO does not address any solvency issues or how much credit will flow into the economy as banks are still likely to reduce their balance sheets given the mediocre economic outlook.

Clearly -- but clearly, this isn't about "companies and households," unless by companies one means banks. Jefferies provides a perfect visual representation of the bottom-line effect an extra €1 trillion's worth of liquidity is having on markets. Not that it isn't already abundantly clear what happens as of late when a) central banks decide to open the pipes and b) try to stem the flow coming out of the fire hydrant, but this should drive it home:

LTRO has also been driving an impressive rally in euro credit markets, especially in new supply, which is booming. Soc Gen:

€35bn of non-financials issuance and almost €45bn in senior unsecured have made the opening salvo in the primary market quite fantastic. Almost every issue printed this year is trading tighter versus reoffer as the initial LTRO-fuelled rally works its magic and has the desired impact of boosting credit markets. Tighter spreads, lower new issue premiums and great demand have combined to keep interest at a high. Issuers are seeing lower funding costs and investors have their performance.

The going right now is so good, issuers should be striking while the iron is hot. High beta core premiums are now in single digit territory and we could expect peripheral corporate premiums to follow suit in due course.

Looks like the only losers here are the vulture types, who according to Goldman are concerned about "LTRO 2 potentially slowing distressed asset sales in Europe." Major bummer, but who knows -- they may find another buying opportunity coming their way at some point.

For those who especially appreciate well-placed double entendre in their sell-side research, Citi now believes it prescient -- based on more deductive reasoning on LTRO -- to divide the non-periphery eurozone countries into a "soft core" group and a "hard core" group (really):

Data from the Netherlands, where banks have increased their take-up from the ECB by more than 4 times between June and December 2011, confirms our view that the country has moved to the group of soft-core countries. In our view the only hard core countries are Germany, Luxembourg and Finland.

A final word from the Jefferies note on the shell game the ECB has been able to pull off with regard to collateral standards:

Investors should keep an eye on shifts in collateral since the injection of liquidity has been done against very lenient collateral standards. Although the ECB could easily engage in further LTRO tenders, in our opinion it would not be in the ECB’s interest to continue to adopt a laissez- faire policy towards the collateral it accepts. One way for the central bank to keep the LTRO in place but reduce its systematic risk would be to tighten collateral standards. This would be a modest ‘risk off’ bet for markets but might not get noticed initially.

Filling your head with euro dreams... @dailycollateral

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MrBoompi's picture

I'm shocked a central bank would resort to money printing and no-interest loans to solve a debt crisis!


steve from virginia's picture


There is no point in becoming pissy about debt. Once on the debt treadmill, there is no getting off.

The US didn't extinguish its post-WWII debts by way of lending at low cost to Argentina. This is from the BIS? Gimme a break!

The post-war public debts of the US were hived off onto Americans desperate to mortgage their slice of the suburban good life. Economists called it 'growth' but in reality it was re-distribution by way of inflation. Rogoff should know better (and perhaps does) but he is a shill for the waste-based American Way.

There has been the constant smear of public into (expanding) private debt then back again. Public debt is extinguished when both the borrower and lender are on the same balance sheet. The alternative is outright repudiation, there is no exit from debts not even repayment with depreciated currency (because currency is never used to retire finance debts!)

Borrower and lender on the same balance sheet occurs because the sovereign (generally) outlives individuals or firms who make/take on loans. This is debt issued/taken on by finance, at the level of finance or the state.

As can be seen, the monetary authority/credit provider -- whomever or whatever that is -- can simply match the rate of redemptions for whatever paper instruments mature and by doing so keep the credit system intact. If the ECB fails there will be an 'Extra-super BCE' that will provide credit in its place. As many people fulminate against the outrage of expanding central monetary authorities' balance sheets, there are far, far more who will accept the free money.

The real problem in Europe and elsewhere is the decades of debt-fueled resource waste that has never provided a return. Countries borrowed to buy fuel, then borrowed more to retire the first round of debt. People have second thoughts about debt when more debt is desperately needed to meet the fuel offer, when the same debt bids the price of fuel farther out of reach.

Debt is simply numbers on a screen but fuel shortages ... hmmm! No driving today (perhaps not ever). Coming to your town.

MrBoompi's picture

I think the "decades of debt-fueled resource waste" as you put it has provided ONLY the returns.  In other words, the debt is never paid down and new debt is required to pay the interest on the old debt.

The value of any loan is not so much the amount of the loan, but the juice you can make off of it.

Sid James's picture

I don't think the ECB do charts.

sparkadore's picture

\is this right?

1.  ECB issues bonds and gets euros, say 100 euro.

2.  ECB issues 1% 3 yr loans ten times that, 1000eu euros to banks, in exchange for??? collateral, perhaps greek notes.

3. The banks loans ten times that, or 10000 euros to sovergin nations in exchange for 3% bonds.

4. The banks expect to get paid back, from a money losing entity (pick your country).

Am \i making sense.  \it seems beyond crazy.

Implicit simplicit's picture

There will be a crisis moment soon when the excess liquidity going towards stocks will be cashed out for fiat in a desperate moment to preserve capital in a slowing market with falling PEs and rising costs of doing business.

misterkel's picture

Test - new member wanting to post.

bank guy in Brussels's picture

Well, you posted. How does it feel?

Don't hesitate and 'test' a non-comment - don't hold back - SAY IT - Tell us what you THINK. That's the better way to 'test'.

waterdude's picture

Did it really take the zerohedge slueth until yesterday to figure out that LTROs massively cut periphery govi bond yields and are, in reality, QE? 


Daily Collateral's picture

No, but we will probably keep harping on it if that is all right with you.

Tyler Durden's picture

If only it was just the ECB's $1.3 trillion...

This chart does not include the already priced in €530 billion LTRO, nor the BOJ's recent Y10 trillion expansion.

Dermasolarapaterraphatrima's picture

What is the correlation now between B/S expansion and money supply expansion? Seems there is a disconnect since banks don't circulate the money in traditional ways if they loan it out at all.

Can we predict how much of this will trickle into the economy (or commodities) eventually?

disabledvet's picture

"Kafka-nomics." Sure we can engineer "numbers"...but numbers do not growth make. As we al know from 2008 "i can default on 0 percent financing just as easily as i can default on 20%." in other words "criticizing it" is simply whining about "outcomes you don't particularly agree with." you're missing the point..."the Big Picture" as it were. Default risk is not changed as "there are a lot of up and downs in the charts presented in the article"....whereas the charts presented above "only move in one direction." move along!

DeadFred's picture

And considering their track record on transparency how sure are we that this is all the money being pumped out there?

Clowns on Acid's picture

Who prices the collateral?

How do we know that the collateral is providing the contracted cash flow?

How does anyone know anything from these feckin desperate facsists?


Implicit simplicit's picture

The ECB and fed difference being the risk is sovereign a.k.-with the euro individual countries buying the shit  bonds; however the collateral assets exchanged for the bonds are constantly losing vaue in a slowing economy. Thuis the ECB is holding acceleratingly more shittty assets (CDOs etc..) just like the FED. Its just a different version of QE.

pashley1411's picture

Its not the free money, though throwing a trillion or two around is the very definition of economically peeing in your bathwater.

Its the reckless throwing good money and good economies in with the bad the keep the project.    Its 1920 Russia, the commissars are going out from the center to find any farm which still has food.  Rule of law was so yesterday.

Withdrawn Sanction's picture

Its not the free money,.."

Indeed. It is not the PRICE of credit, but the QUANTITY of credit. And that quantity will be reduced, involuntarily if necessary, but reduce it will.

Vampyroteuthis infernalis's picture

Once the feeding frenzy is over, then what? The banks will have pissed away their ill gotten gains and still be broke.

FreeNewEnergy's picture

One way for the central bank to keep the LTRO in place but reduce its systematic risk would be to tighten collateral standards.


That's a joke, right?

Manthong's picture

Well, they always have the CDS's to fall back on.