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On Covered Bonds, Collateral Crunches, And The Circular Logic Of Central Banks

Tyler Durden's picture





 

Via Jeff Snider of Alhambra Investment Partners,

Funding In Spain May Get Worse

Since 2009, outside of the megabanks in Europe, the bulk of the rest of the financial system has been completely shut out of the unsecured financing markets - whether that was term debt or overnights (in both euros and dollars).  This was and is particularly true for banks domiciled and operating in the periphery.  That meant they had to turn to the secured lending markets using some form of “acceptable” collateral.  As the crisis turned from US$ mortgage assets to European sovereigns, the ability of these banks to find and pledge sufficient collateral was impeded.  Thus, the ensuing scramble for liquidity through secured lending pushed up the prices on what debt was fully acceptable to the wholesale markets (Germany, Switzerland, Holland, France to a lesser extent, etc).

One of the workarounds to this liquidity problem was the reclamation or retention of covered bonds issued by the Eurozone banks themselves.  For those not familiar, covered bonds are simply debt securities sold by a bank that rank as most senior - they are legally and severably collateralized by that bank's “eligible” mortgage pool.  Instead of a securitized vehicle where mortgage loans are "sold" off balance sheet to an SIV or other entity, the bank has to retain the mortgage loans as collateral for the covered bonds (thus the cover).  In light of recent history and contrary to the last decade, retention is now believed to be more desirable.  In addition, there are strict rules (which vary by country) about the amount of covered bonds that can be issued for a given eligible mortgage pool.  Rules for Spanish Cédulas Hipotecarias, for example, limit the bank to issuing covered bonds no greater than 90% of the eligible mortgage pool (overcollateralization) for residential mortgages and 70% for Cédulas Territoriales (essentially euro-wide public sector loans).

In the event of a bank failure, a special conservator is set up that ensures covered bond investors receive all of the cash flows from the eligible pool before paying any other claims.  Legally speaking, the eligible pool is given a separate class from the liquidation/bankruptcy assets.  And if there are not enough cash flows from the eligible pool then the entire bank mortgage pool is attached and covered bond investors are given priority.  There are additional covenants on the "quality" of the loans that are eligible for use in the covered pool and also limitations to NPLs in the pool (if a certain % of the eligible pool becomes non-performing, the bank is required to replace loans with credits that meet these covenants). 

Given these safeguards there is a high element of security through collateral in covered bonds.  In the wake of the funding crisis, the ECB has given covered bonds a leg up on other forms of collateral, putting covered bonds just below sovereigns (in good standing) in the pecking order of collateral regimes for its various unconventional funding measures.  Because of this, coupled with the high cost of "good" sovereigns, lower tier banks have been using covered bonds to fund their operations in the place of lost traditional funding methods, including, in the case of PIIGS banks, retail deposits.

As the collateral shortage grew acute, Euro banks, Spanish and Italian in particular, began to buy back covered notes from private investors.  Further, on new issues, they began to retain a healthy amount.  Banco Popular, for example, has a total mortgage pool of about €47bln.  The "eligible" mortgage pool runs about €27bln, meaning they are now limited to issuing covered bonds for at most 90% of that eligible pool, or €24.3bln  (the actual limitation is less than 90% since only 52% of the total mortgage pool consists of residential loans).  Through the end of Q1, Banco Popular had previously issued and "sold" €21.4bln in covered bonds, so as late as March this year the bank was already close to maxing out.

But "sold" isn't the right word for it.  Out of that €21.4bln, the bank "retained" €9.2bln, or 43%, of those bonds, ostensibly pledging them to the ECB in probably one or both of the LTRO's.  I have not seen any figures from the bank on how much they have bought back out of the 57% that were actually sold to private investors, but I can guess it was not insignificant.  The bottom line is that the ECB is likely funding at least 34% of the eligible mortgage pool of the bank directly in various collateral schemes.  Perhaps more importantly for future banking and liquidity conditions, Banco Popular has a defined upper limit in the amount of collateral it can issue on its mortgage pool in the form of covered bonds.  Once it reaches that defined upper bound, where it is already close to exhausting this route, the bank will be forced to find a further alternate means for funding its existing loan portfolio.  That is trouble for a bank in a country that saw 5% of its deposit base walk to some other locale in July and the potential activation and usage of the ELA in August.

In January of this year, UniCredit, Italy’s largest bank by assets, issued €25bln in covered bonds to fund its existing mortgage pool in the wake of the Italian banking distress.  The bank also mentioned that it reserved the right to retain a portion of the issuance to pledge as collateral with the ECB (given that LTRO2 was only a month away and UniCredit was heavily involved in the unconventional monetarist scheme it is very likely that a large portion was retained).  There is something very unnatural about these “retained” arrangements since the issuing bank is essentially retaining its own liability to pledge as collateral to the central bank to fund its assets.  Can you really “own” your own liabilities?  Since circular logic pervades the current realm of central banking, this is wholly unquestioned.  In reality, retained covered bonds are just the accounting gloss on direct monetization of past and existing mortgage loans.

Given these atypical collateral dynamics that have taken root in Europe, and the temporary calm covered bond collateral provided, UniCredit’s covered bond sale last week may have sounded a new collateral alarm.  The company was successful in placing €750mm in covered bonds (no word on how much was retained and how much was actually sold to actual outside investors), but it had planned on issuing as much as €1bln.  The shortfall in actual placement was due to the lack of additional available mortgage credits in the “eligible” mortgage poolIt seems as if UniCredit has run into its upper limit.

UniCredit is not alone.  In France, Société Générale (one of the banks rumored to be close to Lehman status on December 8, 2011) surprised the markets last week by tapping an unsecured funding arrangement instead of the expected covered bond sale - again, same story, not enough loans in the eligible pool. 

On Tuesday of last week, Santander did the exact same thing for the exact same reasons.

For Santander and SG, the unsecured markets remain an option, though we can be fairly certain that the unsecured funding arrangements were far more costly on both a marginal and nominal basis.  For UniCredit, Banco Popular and their periphery compatriots (Santander, despite the Spanish name is largely a British bank with Spanish exposure) there is no unsecured funding option, even at the senior levels.  Collateral shortage is a very real issue and in many ways parallels the sovereign debt problems, but it also represents an element all its own - something that is not widely known or covered (pardon the pun).  If banks are running out of eligible mortgages, they will be forced to turn to other means of raising funds, including asset sales.  That offers a very good explanation as to why sovereign yield curves in Spain and Italy flattened and plateaued so dramatically in July – with covered bond issuance hitting against the upper bound Mario Draghi was forced to issue his blanket promise to try to calm unsettled funding markets.

This is all occurring at the same time some of the Basel III requirements are beginning to hit and capital reserves are going to be at a premium.  Banco Popular, for example, is not yet at the 10% capital level to be in “compliance” with the January 1, 2013, Basel "observation" period.  As it is, the size of the bank’s eligible mortgage pool in comparison to its overall mortgage pool is quite revealing about potential capital shortfalls.  Taking into account other security and collateral arrangements, about €18bln of the bank’s mortgages do not qualify as eligible primary collateral for covered bonds.  From that we can infer a lot about the “quality” of those loans, and thus the primary reason these banks are stuck in the covered bond collateral arrangements without other options.

The liquidity noose gets tighter and tighter as banks continue to exhaust funding avenues for simply maintaining their existing bank books.  Since they can barely fund what they have now, expanding lending not just in the Eurozone (euro banks are/were heavy marginal lenders in dollar credit assets through the eurodollar market) is completely impossible - the "broken transmission mechanism" of monetary policy.  Speaking in terms of liquidity, it is possible that as we reach this upper limit in covered bonds that the liquidity crisis will renew right where it left off before the LTRO’s (which renders a failing grade on the LTRO’s in terms of what they were supposed to accomplish, just ask CIF). 

That might force the ECB to loosen collateral restrictions further (restrictions were adjusted not that long ago on June 22), but in the covered bond space such a move might further upset the marketplace since covered bond investors will not take kindly to losing collateral protections and covenants.  As it was, the potential "bail in" solution for Spain floated earlier in the year coupled with the various bonds that have ended up at the ECB threaten to diminish the seniority of the covered bonds since the ECB refuses to take losses (the precedent set in the Greek PSI earlier this year).  The more bonds pledged to the ECB the greater the potential for ECB erosion of overcollateralization and then cramming down losses, pushing covered bond investors down the capital structure to par with unsecured senior debtholders.  The ECB and its dependents are painting themselves into a smaller and smaller corner.

Marginally, covered bonds as collateral to the ECB is an extremely important bridge holding the shaky liquidity system together as it is now.  Despite all the monetary measures and collateral bypasses, the funding reality remains largely unchanged over the past year – private arrangements are little to non-existent.  The two variables that have changed most dramatically are the willingness of retail depositors to remain in place given the dynamics of each bank’s undesirable loan book and the ECB’s willingness to take up the slack created by that deposit flight (through both unconventional collateralized arrangements and TARGET imbalances).  Draghi and his rate caps have no impact here.  If, however, the covered bond bridge is pushing up against its very real statutory and quality limitations, that might mean the ECB is now fighting a two-front funding war – retail deposit flight and collateral diminishment at the same time.  In any event, the diminished potential of covered bonds for liquidity means that much more funding flexibility, one more funding source or marketplace, is no longer available to the second tier and below banks.  That gets problematic given the exposure of top tier banks to these markets and these banks themselves (French banks, in particular, seem to have a lot of periphery-based subsidiaries that run into periodic funding and capital issues).

It is vitally important to remember how these plumbing issues came about in the first place.  One of the primary lessons for central bankers coming out of decades of studying the Great Depression was the unfortunate liquidity conditions that saw “good” banks ruined with “bad” banks.  That meant, for central bankers, the public could not be trusted with discerning between “good” and “bad” banks, meaning central planning in the banking system itself was actually more desirable than free markets.  From that it was inferred that contagion could be avoided through centralized liquidity schemes.  Therefore central banks could perform the public service of sorting good banks from bad through collateral arrangements – if a bank has enough “good” collateral on its books it must be fairly called a “good” bank worth saving.

In light of that original framework for central bank intervention, the twisting and distortion of collateral schemes belies that original intent.  If banks possess enough “good” collateral to be salvageable, the opposite must also hold true.  Banks that do not possess enough “good” collateral have self-selected themselves for extinction and resource re-allocation.  That is the only interpretation that would preserve a central bank philosophy consistent with central bank goals of actual public/free market service.  Anything outside those bounds is venturing away from true economics and monetary economics into politics.

Central banks and mainstream economists continue to fall back on the idea that the banking system and the global economy are one and the same, inseparable.  Therefore the banks must be saved at all costs or we risk total economic chaos.  Yet, that would only be true of the “good” banks.  A market system needs to feature a self-correction that destroys “bad” banks lest they interfere with the vital task of intermediation in the real economy – “bad” banks give out bad loans so a healthy economy must contain only a minimal proportion of bad banks.  Therefore, central banks have it exactly backward.  The “bad” financial economy must actually be separated from the real economy lest we remain stuck in economic reversal and malfunction.  Since these “bad” banks have shown themselves to be as such to central bankers by appealing to unconventional collateral schemes, the next step should actually be the easiest.  Instead of perpetual liquidity problems, central banks could simply wind down these institutions and remain consistent with the public/free market philosophy they espouse.

Reality is, of course, far less straightforward.  Central banks are not paragons of economic virtue despite their PR campaigns promising otherwise, and that is no more apparent than at the ECB.  At least we can call a spade a spade in light of unending collateral problems.  There is no economic argument for maintaining self-selected bad banks.  Free markets demand their extinction.  Anything short of that will result in escalating and perpetual liquidity and solvency crises until the real economy is freed from the yolk of bad banks and their dis-intermediation.

There is no real wonder as to why we have exactly that right now – the intrusion of politics done in the name of economics.  The cost of this political intervention is malaise and re-recession.  Markets, however, are far less conflicted (outside of interventions).  The potential upper bound of the covered bond regime demonstrates once again that the intrusion of politics also has an upper bound.

 


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Sun, 09/16/2012 - 11:42 | Link to Comment TheSilverJournal
TheSilverJournal's picture

Gotta love(?) those Central Planners, always thinking THEY know better than the market.

Sun, 09/16/2012 - 11:59 | Link to Comment IndicaTive
IndicaTive's picture

My parents called me this weekend just to tell me they've decided to put some of their nest egg into physical silver. Even they see the writing on the wall. I've often told them, if you want to leave anything to your grandchildren, leave them silver eagles. 

Sun, 09/16/2012 - 12:46 | Link to Comment Oh regional Indian
Oh regional Indian's picture

LaRouche PAC's expose of Santander is well worth a search/read.

Quite revelatory.

ori

Sun, 09/16/2012 - 13:00 | Link to Comment Peter Pan
Peter Pan's picture

My next purchase will be teflon coated fan blades.

Sun, 09/16/2012 - 13:15 | Link to Comment malikai
malikai's picture

Go for the titanium ones. Teflon chips under shock.

Sun, 09/16/2012 - 14:52 | Link to Comment 847328_3527
847328_3527's picture

My in laws just bought some of those 2013 silver proof snake coins....very shiny....cool.

Sun, 09/16/2012 - 12:23 | Link to Comment Hedgetard55
Hedgetard55's picture

"Get to work, Mr. Chairman." SEN Chuck Schumer.

Sun, 09/16/2012 - 13:34 | Link to Comment LMAOLORI
LMAOLORI's picture

 

 

FUBU

The Stock Market Votes for Obama

snip

In fact, history shows the stock market predicts the election results, not the other way around. Not to keep you in suspense, a good market is good news for President Obama and bad news for his challenger, Mitt Romney. At least that's the record of presidential elections going back more than a century with a near-90% accuracy record.

14 Things Obama Doesn't Want You To Know About The Last Four Years

http://www.huffingtonpost.com/2012/09/04/obama-doesnt-want-you-to-know-economy_n_1855172.html

Has Bernanke Held the Keys to the Presidency all This Time?

Intrade: Fed helped Obama's re-election odds

Fed Move Unusual When Stocks Are Hitting Multi-Year Highs

Sun, 09/16/2012 - 23:35 | Link to Comment StychoKiller
StychoKiller's picture

The Decepticratic Senate has NOT passed a budget in 3+ years, WHO is it that needs to get to work again?...

Sun, 09/16/2012 - 11:43 | Link to Comment All Out Of Bubblegum
All Out Of Bubblegum's picture

"A system which encourages saving and capital accumulation will always outperform one which incentivizes consumption in the long term. As the presenter’s (very noble) intention was to help poor rural communities, I hope someday he comes to understand the crucial principle that quality of life derives from surplus and capital investment, not from outright consumption."

 

Brazil and the Global Payments Forum

 

http://blog.bitinstant.com/blog/2012/9/15/brazil-and-the-global-payments...

Sun, 09/16/2012 - 12:05 | Link to Comment FreedomGuy
FreedomGuy's picture

I have seen economic models that show growth is actually more related to savings (and therefore investment) than raw consumption. However, our tax codes and all incentives run toward consumption. Without growth in real wages and productivity there cannot be any growth in consumption. There also cannot be any growth in asset prices or value. This is what the banks, central planners and governments are up against.

Sun, 09/16/2012 - 11:44 | Link to Comment Racer
Racer's picture

Sounds very much like an Enron style smoke and mirrors deliberate trickery and have so many trails to vaious places no-one knows what the true picture is any longer and hide the enormity of the situation

Sun, 09/16/2012 - 11:49 | Link to Comment kevinearick
kevinearick's picture

Self-referential...should a been a plumber/can't export that job...crack me up...

so, i'm going to check out tk wizardry at u mass a, and the masters of the universe have tied the elevators together with the u mngt info system...some kid gets inquisitive, the elevators start doing funly things, and pretty soon everyone is covering their ass because the entire bribing system is exppsed, only to be replaced by a new bribing path, once the usual suspects are rounded up...

Sun, 09/16/2012 - 11:57 | Link to Comment kevinearick
kevinearick's picture

So, i'm doing the mba thing, you know, build a bridge out of common materials to practice teamwork, translate determine who is a shark and who isn't...you know what they say about sharks...let them think they are moving, until you don't...

Sun, 09/16/2012 - 15:13 | Link to Comment GeorgeHayduke
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I don't know that I would go for an MBA in today's environment (not that I ever would actually). I liken an MBA to living in a pretentious gated neighborhood these days. If given a house in a pretentious gated neighborhood today, I would have it on the market tomorrow. It's like holding up a neon target for people's anger and aggression when things get worse, which they will. There's a good chance the angry mobs will storm those gates first and quite easily and start taking out their anger. Then when the mob is done hanging bankers and gated community folks, I wouldn't want any of them to know I had an MBA because they might not be done getting out their anger quite yet.

Just my thinking on things and the kinds of people I grew up around. I could be wrong.

Sun, 09/16/2012 - 11:51 | Link to Comment Whoa Dammit
Whoa Dammit's picture

Just wait until the inflation from QEx starts here. It will be the end of low rates on Treasuries. Unintended consequences are a bitch.

Sun, 09/16/2012 - 11:52 | Link to Comment DoChenRollingBearing
DoChenRollingBearing's picture

I sure do hope that more banks, both in Europe and the USA, start buying GOLD as a solid asset.  

Bank circle-jerk buying of junky bonds, yeah that sounds like it will work out great.

It's hard for me to even comment on Italian banks even though we are here on a visit.  But, all of the Italians we talk to say things are BAD.  One rich Italian lady friend os my wife's says she is SCARED, wants to sell here house and move to the USA (where one of her children lives).

We are in Matera now (where part of "The Omen 666" was filmed as well as biblical movies), quiet small place.  No "Compro Oro" signs, I will likely see those when we go to Taranto (Italy).  Hey!  Turns out that extreme SE Italy is very interesting!  Y'all know how to ahold of me if you want any recommendations re Italy...  

|;.!

Sun, 09/16/2012 - 12:08 | Link to Comment FreedomGuy
FreedomGuy's picture

That is actually not a bad bet. Gold not only functions as a stable and even appreciating asset currently but can be used to settle debts. If you were one of the purchasers of debt of any of these PIIGS countries I would be excited to have debt settled in gold. Given currecy depreciation expectations I might even be willing to give a discount to debts settled in gold.

This is something to watch for in the near future.

Sun, 09/16/2012 - 12:59 | Link to Comment DoChenRollingBearing
DoChenRollingBearing's picture

+ 1

Yes, if I were a holder of debt in PIIGS bonds, I would very happily settle for gold instead of the bonds, and yes I would give a discount...

I wish I had the reference handy, but a few months ago I read that (purportedly) that India could offer gold to Iran for oil, and probably get away with paying a lot less gold than its current $ price.  This would be even more likely and possible if they cut Iran off from SWIFT.  Then we might see Freegold...

Sun, 09/16/2012 - 13:19 | Link to Comment malikai
malikai's picture

Isn't that pretty much the only choice after the great liquidation comes?

Who'se going to trust SDRs or any other bastardization of money once this is finished?

Sun, 09/16/2012 - 20:21 | Link to Comment FreedomGuy
FreedomGuy's picture

John Corzine will sell them to you. You can trust that guy. Joe Biden said so.  Just open an account and go for it! His new company will be LMFAO Global.

Sun, 09/16/2012 - 12:27 | Link to Comment bank guy in Brussels
bank guy in Brussels's picture

Says above

« There is no economic argument for maintaining self-selected bad banks. »

As much as we'd like to think this is true ... that it's good to liquidate the failed crooked banks ... yet even major dissident critics of the Western system like gold guru Jim Sinclair, quite disagree, although with great regret.

According to Sinclair and many others, the Western world derivative monster, and all the shadow-banking contagion side effects, really do threaten Armageddon if we let the bad banks go under ... they say the crooked house of cards is too inter-connected now.

This issue needs to be better covered by someone really knowledgeable ... but it seems many people are just proclaiming an opinion or guessing.

Consider what ZeroHedge itself covered, about how the whole Western economic world almost blew up 84 hours after the Lehman bankruptcy.

'How The World Almost Came To An End At 2PM On September 18':

« On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts and announce a guarantee of $250,000 per account so there wouldn't be further panic out there.

If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it.

We are no better off today ... »

http://www.zerohedge.com/article/how-world-almost-came-end-2pm-september-18

Sun, 09/16/2012 - 12:37 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Two words, "margin call".  Eventually someone wants to cash out or see the real value of those assets and collateral.  Fucking bring it.

Sun, 09/16/2012 - 14:31 | Link to Comment resurger
resurger's picture

Do you consider those mortgages as a liability or an asset to the bank (The physical mortgage is a liability) but the loan is an asset!

Is it legal to sell the mortgage to a third party as a covered bond Law?

Sun, 09/16/2012 - 14:43 | Link to Comment Yen Cross
Yen Cross's picture

In the "old days" it was called [cross collateralization].   Now it's renamed "Credit Default Swap"!

Sun, 09/16/2012 - 14:47 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Doesn't mean shit when possession  is the law and no one can afford to pay the mortage.  The loan is only an asset if someone can actually pay it.  I don't carry debt and when I win a paper game I re-invest that profit in physical assets of real value to myself and my employees.

Paper is buring, get the fuck out or gamble with what you can afford to lose only.

You are acting like the rule of law still exists - FAIL.

Sun, 09/16/2012 - 14:56 | Link to Comment Yen Cross
Yen Cross's picture

 I have my " Metal cache", I just don't advertise it! I "pay attention", to what"Good Fellas" like yourself write.;-)

Sun, 09/16/2012 - 14:56 | Link to Comment 847328_3527
847328_3527's picture

<<90% of the eligible mortgage pool>>>

Is 90% really enough 'cpverage?' Seems that residnetial mortgages can no way be worth more then 60-70 cents on the dollar now in Spain. Am I misreading something?

Sun, 09/16/2012 - 20:33 | Link to Comment FreedomGuy
FreedomGuy's picture

Bank Guy. You bring up a good point. I wonder even as an Austrian economics type libertarian if I would have had the guts to watch the system crash. Intervening is actually the chicken play, not the courageous stand. I think unless one has prepared for that type of moment it is hard to make such a quick decision.

You banker and trader types: What is the solution to runs on the bank? It seems to me that contracts are the key. If a bank wants to lend out a lot of money it needs to have lots of contracts out in the form of money markets, CD's. etc where the depositor cannot suddenly remove the cash. If a depositor does remove it early before end of contract it should have steep penalties and in times of crisis the bank can legally refuse to return the principle till the end of contract. I know the FDIC guarantees deposits but that does not seem to work very well and only covers the "little guy" who really doesn't break the bank.

Banks lend out a lot of money based on demand deposits, do they not? They leverage them 10, 20, 30 to one and pray not many will ask for their money suddenly. There is no contract to give the money to the bank for any amount of time.

How do you properly and responsibly prevent a run on the banks and even financial houses in times of economic stress?

Tue, 09/18/2012 - 06:15 | Link to Comment honestann
honestann's picture

I'll tell you one thing as someone who aligns fairly closely to Austrian economics.  I would have been ABSOLUTELY THRILLED to watch everything crash and burn... then subsequently recover with whatever assets remained in less irresponsible hands.

But I will acknowledge one potential problem exposed by the corzine affair.  If the slimeballs who ran those corporations were able to steal all the privately owned funds of every individual who had an account with their company before they vanished onto their 300 foot yachts... AND... the government let them get away with that as they did with corzine... well... things could have gotten "interesting".

But now that I think about it, this would have been a large and blatant enough event to spur thousands if not millions of people to take up arms and do what needs to be done.

So yeah, I would have let it happen, and would have loved every minute.  The world would be a vastly better place today as a result of the dislocations that followed.

Mon, 09/17/2012 - 01:38 | Link to Comment honestann
honestann's picture

It matters zero how huge the derivatives market is or was.  The only people involved are the slimeballs who wrote the contract.  The economy-at-large is not somehow responsible for any corporation that goes bankrupt, whether that corporations is $100 in the hole or $100-quadrillion.  The lender or counterparty-betters who make such huge bets simply don't get paid.

This is a triviality.  When a private party bets $100-quadrillion dollars --- and finds some morons stupid enough to accept his bet --- then loses the bet, the winner cannot collect on his bet, and has nobody else to complain to.  Whenever you make a bet, you are responsible for judging the viablility of the other party to your bet, evaluating the risks they might not pay, then accepting the outcome, whatever that might be.

So I don't care if the value of derivatives is 1000e+250 or 1000e+250000 or 1000e+2500000000.  It simply doesn't matter.  Either way, the better simply doesn't collect.  Kabish?

Sun, 09/16/2012 - 12:43 | Link to Comment kevinearick
kevinearick's picture

I gave my "crew" a simple engineering solution, their eyes glazed over, and they were locked up for the duration. the winning team built an arch, with high 5s all around. while the bank builds its latest arch, and G is locked up, you are going to take advantage of marginal utility, like filling the remaining seats on an airplane, only it's not going to be an airplane when youare done. Most of the robots will be watching the movie as normal and those near you will be in shock(don't forget to make them comfortable).

Sun, 09/16/2012 - 12:47 | Link to Comment falak pema
falak pema's picture

here is an interesting take from Le Figaro saying the great banking union scheme in Euro zone which will give more power to ECB and Eurocrats to monitor and control 6000 banks in Euro zone is now treading water. A lot of countries do not want it; and even Schauble of Germany is prudent.

SO the famous ECB safety net to control and protect banking systemic risk in Euro zone  is now becoming problematic. 

Le Figaro - Conjoncture : Douche froide sur le projet européen d'union bancaire

Sun, 09/16/2012 - 13:01 | Link to Comment ebworthen
ebworthen's picture

It begs the question of why anyone should pay their mortgage or taxes when central banks are using taxpayer money to buy mortgage debt to benefit banks.

That, or give people money to pay off their mortgage, it is little different.

If you are going to have a circle jerk shouldn't everyone be invited?

Instead it's bureaucrats and bankers only, leaving the mess to the taxpayer.

Sun, 09/16/2012 - 13:18 | Link to Comment Winston Churchill
Winston Churchill's picture

As a benefit it would actually make the MBS crap worth something.

Cuts out the elites skim,so will not happen.

Sun, 09/16/2012 - 13:45 | Link to Comment Yen Cross
Yen Cross's picture

A lesson in "semantics", albeit the article is insightful, The ECB and Fed. are subordinate to NO-ONE ! 

 

Awe did we upset the Author? The ponzi sovereign "bond purchases" to/from " zombie" banks has been going on forever. It's called "wonton" sterilization "European Style".

 

Sun, 09/16/2012 - 23:43 | Link to Comment StychoKiller
StychoKiller's picture

"Wontons" fill my taste buds with wanton lust...

Sun, 09/16/2012 - 13:53 | Link to Comment Schmuck Raker
Schmuck Raker's picture

 

Outstanding article!

Sun, 09/16/2012 - 13:53 | Link to Comment Eally Ucked
Eally Ucked's picture

If you wonder why they do what they do just consider one simple fact that GDP of western countries consist mostly of financial operations and machinations. If they decided to get rid off those bad banks and write off bad debt the GDP would fall from 30 to 40% and then everybody would wonder where are those bastions of wealth and power going, would their curriensies still hold any value. 

Sun, 09/16/2012 - 14:09 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Correct, less and less of it becomes about actually producing something of real value.  Unfortunately, people need things of real value in order to survive.  Interesting times indeed.  People will be re-learning what real wealth is again shortly.  In the meantime there is the issue of 7+ billion mouths to feed.  Something will give, it always does.

Sun, 09/16/2012 - 14:37 | Link to Comment Yen Cross
Yen Cross's picture

Ebola "BITCHEZ"<> Good post.

Sun, 09/16/2012 - 14:08 | Link to Comment Atomizer
Atomizer's picture

 

 

Breaking NewZ.. Central Banking organizations have expounded on how to raise much needed monies. Thanks to the resent Obama Campaign efforts, Yard Sales shall flourish around the globe.  

 

YardSaleForObama.com

Sun, 09/16/2012 - 14:26 | Link to Comment IndicaTive
IndicaTive's picture

Remember the 80's action flicks about the future? This ad reminded me of the background noise in those movies. The commercial that showed just how fucked-up things would be in the future.

Sun, 09/16/2012 - 14:28 | Link to Comment resurger
resurger's picture

Can you really “own” your own liabilities?  Since circular logic pervades the current realm of central banking, this is wholly unquestioned.  In reality, retained covered bonds are just the accounting gloss on direct monetization of past and existing mortgage loans.

Interesting thought, i dont know really whether the mortgage loans should be considered on the liability side (the loan is an asset to the bank, but the mortgage is a liability to the bank if the loan is healthy)

are these covered bonds sold to the ECB as good mortgage loans or as non performing mortgage loans? Am assuming the following:

1- the ECB get's the interest proceeds from thoes covered bonds

2- The bank get's face value.

3- The mortgage payer (client) gets fucked when he defaults on his mortgage / or he gets his asset "vaporized" , double penetration.

But in America, it's completely different...

 

Sun, 09/16/2012 - 14:38 | Link to Comment Urban Redneck
Urban Redneck's picture

The circular relationship (and mirrored accounting entries for anyone who has seeen the internal balance sheets) between BHCs & FRBs in the USA...

In banking and money laundering- The Circle is the Perfect Shape.

Sun, 09/16/2012 - 14:36 | Link to Comment disabledvet
disabledvet's picture

As a layman what has stood out to me vis a via the headlines is what strikes me as the rather paltry sums discussed relative to say "the problem of bailing out Spain." 3 to 5 trillion doesn't seem all that large to me at all considering the scope and scale of the ongoing programs in the US and how they're "dealing with it" (the current MBS boondoggle comes to mind.) I'm only "hazarding a guess" as I and apparently ALL of us do now (since even guessing is considered a national security risk covered undered Full Retard Directive 8675309) but methinks it has something to do with ye olde "reserve currency thingamajig"...but of course we're all just guessing cuz "zee people doing zee stealing do not appear to be zeee guessing at all."

Sun, 09/16/2012 - 15:04 | Link to Comment Darth Rayne
Darth Rayne's picture

Having a fiat currency as the worlds reserve currency is very clever. Abusing it to death isn't.

 

Gold bitchez   :-)

Sun, 09/16/2012 - 18:33 | Link to Comment lotsoffun
lotsoffun's picture

as a layman - you can open an encyclopedia and read that spain is 30 million people and usa is 300 million people - and 3 trillion compared to us x 10 is 30 trillion.  but - of course.  that's not much money, if you think about it.  because if you further think about it - 3 trillion for 30 million people - yes.  do the math - prove me wrong - is........????  euro 100,000 per man/woman/child.  that's a lot of cash.  - i'm not sure where you got you 3 trillion from.  sounds like a very much too large sum.  the last bailout i saw from ecb sources was 1/3 of that - which is still 30k per person - a huge amount of money.

geez - goldman must have really sold these guys some great derivatives

 

Sun, 09/16/2012 - 14:42 | Link to Comment pauhana
pauhana's picture

The ruse of using a stinking pile of toxic crap mortgages as collateral for bank bonds which are then pledged to the ECB for money good is no different from what we are doing here with QE-Whatever.  The MBS our banks are selling the Fed is just as toxic.  The idea that there will be no consequences is ludicrous.  The whole world will be embroiled in the coming economic catastrophe that is now right around the corner.  Buy rope.  It will be in short supply.

Sun, 09/16/2012 - 14:44 | Link to Comment Darth Rayne
Darth Rayne's picture

The Fractional Reserve banking System requires continuous growth. It is a basic ponzi scheme that requires everyone to pretend it isn't. All these clever financial instruments are designed to do one thing and one thing only. To maintain the illusion for as long as possible.

The Governments and Banks are trying to maintain control over the people for as long as they can. A few wars would distract us and increase GDP and employment. Not very productive though. Wasting time and effort on manufacturing devices to destroy property and kill other people. Thus proving that GDP and employment aren't ideal indicators of the Worlds Health.

 

What is this illusion I mention? The illusion that Banks and Government are more powerful than the PEOPLE.

Sun, 09/16/2012 - 14:57 | Link to Comment Darth Rayne
Darth Rayne's picture

It has been suggested that the American PEOPLE have about 200 million firearms. When 10% of the PEOPLE decide enough is enough then could they seize control of their Government?

Obama would lose control of his bladder if 1% decided enough was enough. 2% would require him to wear brown trousers and a diaper. 3% and it would be a pencil up each nostril and the placing of his boxer shorts upon his head. His response to any question would be 'wibble'.

 

I am certainly not suggesting civil war. I am trying to tell you the PEOPLE of the United States that you are more powerful than your Government.

 

We need more Zero Hedge and less CNN. Keep up the good work.

Sun, 09/16/2012 - 14:59 | Link to Comment Darth Rayne
Darth Rayne's picture

If I have to work to earn money, the bankers and government just print it.

Does that mean that I am a Slave?

Mon, 09/17/2012 - 01:32 | Link to Comment honestann
honestann's picture

Who is more powerful?  As long as the people are stupid and/or confused, who is more powerful remains...

predators-DBA-governments
predators-DBA-central-banks
predators-DBA-large-corporations
predators-DBA-transnational-organizations

Until humans understand governments, central banks, corporations and all organizations are nothing but FICTIONs, humans are screwed.  The reason the predators-DBA-governments are arming-up in spades lately is... they fear more than 0.001% of humans will figure out the scam of fictions --- and come after the predators hiding behind the fictions.

Sun, 09/16/2012 - 15:37 | Link to Comment GCT
GCT's picture

Good read ZH thanks for posting. 

Sun, 09/16/2012 - 16:10 | Link to Comment NewWorldOrange
NewWorldOrange's picture

Just have to say. This is one of the best articles I've seen on ZH. Impeccable logic, great flow, superb choice of terms in just the right places, emphasis in all the right places, and clearly written by someone well-versed about financial matters and recent history of the same. And plenty of the essentials without tangential digressions. Just excellent.

It seems pretty clear to me that in the aggregate (globally), collateral itself has reached its upper bounds. We've reached the Ponzi Apex. I don't even think they could kick the can further by creating a newfangled musical chair if they tried

Capital? Already deeply in the red in the aggregate. No "collateral" there -- capital is what collateral itself is needed for as a back stop.

Labor? They already collaterlized the all the labor of every existing human, their kids, grand kids...so there's no labor left as "collateral". No one will put any greater value of "the full faith and credit" now that it's gone QEternity and every sign is that every economy is doomed to stagflation, with the Fed just having not only admitted it but ensuring it.

They've "de-collaterlized" entrepreneurship so to speak. Who would dare? Who has the capital, or collateral? More of that "circuluar" thingy.

"Land" (and the improvements thereto, mineral underneath, etc)? All collateralized, beyond it's true market value (okay, property on the moon or the ocean floor may not be, but discounted to present value...) Except for a few things: Gold, silver. It won't surprise me one bit to see the (IMO, already highly coordinating) CBs reverse long-term quiet policy and allow gold to rise to its natural price, and then pledge that as collateral for themselves since THEY have now become the only real collateral of any significance (marginally speaking.) In doing so, they will drive it higher, thus providing even more and better collateral. All signs are, from my perspective, they've figured this out. "If we can't beat those gold bugs, join 'em."

Gold bitchez. It's not only going to rise in spite of CBs, but probably THANKS to CBs who will now intentionally allow it to ascend. Note this also tends to explain the remarkable accumulation of gold by CBs of late even while they continue to disparage it (they'd love to talk the price down while they're buying it, of course.)

Maybe I shouldn't have mentioned "Land...all collateralized, beyond it's true market value...okay, property on the moon or the ocean floor may not be, but discounted to present value..." Don't want to give the douchebags another idea for a bubble. Might get them thinking in terms of more Dutch tulips...

 

Sun, 09/16/2012 - 18:13 | Link to Comment indio007
indio007's picture

+1 for "Ponzi Apex"

 

 

Sun, 09/16/2012 - 20:06 | Link to Comment steve from virginia
steve from virginia's picture

 

 

Central banks are not paragons of economic virtue despite their PR campaigns promising otherwise, and that is no more apparent than at the ECB.  At least we can call a spade a spade in light of unending collateral problems.  There is no economic argument for maintaining self-selected bad banks.  Free markets demand their extinction.  Anything short of that will result in escalating and perpetual liquidity and solvency crises until the real economy is freed from the yolk of bad banks and their dis-intermediation.

 

The entire point of lenders of last resort is that all 'legitimate' collateral to the central bank is unquestionably good and that the banker offering it is irrelevant. Legitimate collateral is that which has been traded- or is tradable on 3d- party markets or is 'risk-free'. (Back in the good old days, this used to be EU sovereign debt).

 

Now, collateral is under a cloud because one bit is indistinguishable from the rest, most is debt, a tiny fraction represents actual utility, goods or trade: 'covered' bonds are more debt. What are they covered by? Layers of false promises ...

 

Which gets to the point of commercial banks offering defunct collateral for unsecured loans by central banks: to do so means no real lender of last resort. Working backwards, there are many reasons for capital flight and runs out of institutions in the EU and pock-marked collateral and its acceptance by central bank(s) is one of them. Central banks are just as bankrupt as the rest of the banks.

 

Which also means that any bank failure is systemic or appears to be, there is no confidence in the SYSTEM, not individual banks.

Sun, 09/16/2012 - 22:15 | Link to Comment Pejorative Requiem
Pejorative Requiem's picture

Good post.

"Good collateral"? When you're refering to paper? Todays paper? And man, there ain't enough precious metal in the world to cover this mess.

Sun, 09/16/2012 - 23:51 | Link to Comment StychoKiller
StychoKiller's picture

[quote] And man, there ain't enough precious metal in the world to cover this mess. [/quote]

At current valuations, no...

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