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Deus Ex LTRO
Via Peter Tchir, of TF Market Advisors,
So the market has completely latched on to the idea that LTRO is back-door QE.
Does this make any sense and can it even work?
So banks can borrow money for up to 3 years from the ECB. They can buy sovereign bonds with that money. Those bonds would be posted as collateral at the ECB.
The bull case would have banks buying lots of European Sovereign Debt with this program.
The purchases would be focused on Italian and Spanish bonds with maturities less than 3 years.
Buying bonds with a maturity longer than the repo facility is risky. The banks would need to be assured they can roll the debt at the end of the repo period. Some may be convinced, but the bulk of the purchases will be 3 years and in so that they loans can be repaid with the redemption proceeds.
Looking at 2 year yields, Italy and Spain offer some value, with yields of 3.2% and 4.8% respectively. Belgium at 2.4% may attract some interest. France is too tight at 0.9% to see its bonds purchased as part of the LTRO.
Ireland and Portugal yield 7.6% and 13.9% respectively. The yields are attractive, but the risk of default is too high in my opinion for even an aggressive bank to play around with. Ireland has mentioned the possibility of needing to renegotiate their package. Any bank that decides to load up on bonds of Portugal or Ireland would risk backlash from even optimistic investors.
So realistically, the bulls would hope for banks to load up on short dated Spanish and Italian bonds. Will LTRO really encourage so many new purchases? From a funding standpoint, these bonds were already relatively easy to finance. There is a developed and reasonably efficient repo market for these bonds. It would be difficult to get term financing, but was relatively easy to roll the repos. The ability to get the term financing makes it easier for a bank to put the trade on, but it is an incremental improvement, rather than a dramatic change.
So banks buy the bonds and earn the carry and all is good? Not so fast.
New Purchases vs Existing Positions
Banks are struggling to borrow money right now to finance their existing positions. How much of LTRO will be used to finance new bond purchases, rather than to replace existing forms of funding? Any bank that is already running a big sovereign debt position will look to LTRO to replace existing forms of financing. They can eliminate the repo roll risk on bonds they are financing in the repo market, or they could stop attempting to borrow in the interbank market. Those are positives for the banks as they can earn more carry (cheaper financing) and reduce roll risk (3 year term). But that doesn’t create new demand for bonds.
So the LTRO can help the banks with their existing funding problems without a doubt, but it is unclear that encourages new bond purchases.
How much can a bank do?
Let’s say a bank thinks this is the greatest idea ever. Could a bank do this with 100% of their assets. Yes, that is extreme, but it highlights the issues. A bank puts 100% of its assets into LTRO trades. What price would you pay for the equity? If all the bank had on its books was Italian bonds funded to maturity, how much is the equity worth? In MF Global’s case, it was worth ZERO, but there were some concerns about MF’s ability to continue to roll the position. The equity would be a huge leveraged bet on an Italian default. It would be binary. The income is leverage * net spread. The equity would be wiped out if there was a default. Banks will be tying up some amount of equity in the trade (LTRO shouldn’t be providing 100% financing, there is usually a haircut of some sort).
Would private equity gravitate towards banks making that bet, or would it be pulled. What about private creditors? Would you lend to a bank, when the bulk of their book is based on the theory that Italy and Spain won’t default. Here it is important to remember, that most banks are already overexposed to these bonds under the assumption they wouldn’t default. Banks have not accumulated these positions under the assumption that default was a possibility, that fear is relatively new. Will banks that are underweight Spanish and Italian bonds really decide now is the time to buy?
To buy now, you need to believe that the default risk is gone. Since NOTHING about this program addresses solvency, you cannot change your default assumptions. You would be betting that the problem is really liquidity driven and that this program can solve that. But how can you know that? You need to assume every other bank will add significantly to their exposure. No one bank can grow their exposure too large, without losing all access to the public debt markets and seeing their share price drop. So each bank can only add incrementally. Since the solvency problem hasn’t been addressed, you are buying in the hopes that some other bank buys too. If everyone buys and takes on even greater exposure to these weak countries, then the liquidity and debt issuance risk can be addressed. But what if strong banks don’t think it is smart to take on more risk.
Why would a bank that is afraid of default take on more risk? If you have largely avoided the problem, why would you participate now? You have been involved in government led negotiations on Greek debt (or at least you know people who have been). You are afraid that Ireland and Portugal will demand concessions. Will you really take quasi government money to buy government debt? The solvency hasn’t been addressed and you are exposing yourself to political manipulation. Is some carry really worth it? Will you really decide that you can’t find a better investment opportunity (like buying back your own debt or shares?).
Adding to your sovereign debt positions means you really believe there is no risk of default, and that using the program, won’t lead to renewed pressure on your business from politicians. I don’t see that happening. MF Global, although different, is also too fresh in everyone’s mind. If a bet becomes disproportionately large, it can kill you. Not only lenders may flee, but counterparties may also flee. It is possible that firms will choose not to do business with you. There is no shortage of counterparties that clients can deal with. Why do business with a bank that seems to be putting on risk that leads to a binary outcome?
Even without default risk, will there be mark to market margin requirements? Although the bonds are short dated, they could sell off again. If they sell off, you have to come up with margin for the repo agreement. Where will you get that? Probably from the ECB by posting more assets, but that is a risk. The mark to market risk and variation margin doesn’t go away (unless the ECB is providing all this money without variation margin). In a totally circular world, the more banks that participate in size in the program, the less likely that you will have mark to market margin calls, but if only a limited number of people participate, then the risk is high and you will be isolated by the market.
So it is a weird kind of Prisoner’s Dilemma. You want to act last. You want to make sure other banks are participating before committing yourself. By waiting, you would risk earning less carry, as the bonds you purchase will have increased in price, but that impact is minimal. If the leverage is high enough and the cost of funds is low enough, than that opportunity cost has minimal impact on your decision. If you load up on bonds and find that no other bank has participated, then you will stick out like a sore thumb. Investors won’t trust you, and you will likely have a mark to market loss, and will be on the front page of papers questioning why you participated and others didn’t. So it is smart to wait and see what others do. If everyone is waiting to see what someone else will do, we will likely see minimal participation. The weak banks will add to their all-in trade, but the stronger banks will focus on other business lines that can be profitable without so much intervention or risk.
So what will happen?
There will be significant interest in tapping the LTRO for existing positions. Some small amount of incremental purchases may occur at the time, but the banks will use this to finance existing positions. This should help bank credit spreads. It should also show up in measurements like OIS as it would reduce pressure in the interbank funding market. This is positive, but a relatively minor positive, and seems more than priced in.
We will likely see the yield curve in Spain and Italy steepen sharply at the 3 year point. Buying longer dated Italian paper will remain very risky and the banks will be more interested in retaining positions 3 years and in.
I think we have already seen the initial impact. Now we will wait to see rates do well, but will be disappointed. The big banks with risk management departments will decide to decline. The risk/reward just won’t be attractive to them. We will find out that places like DB don’t participate and that small weak banks do. That will actually start another spiral on those weak banks, as people will sell the shares and they won’t find lenders outside of the ECB as no one will trust their discipline. In the end, this won’t do much for the sovereign debt market, but will shine a spotlight on which banks should be shorted and will possibly expedite their default.
I’m still nervous that the IMF or China or someone has a real program, but up 35 points on SPX from yesterday on hope of LTRO seems overdone – again.
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Europe is fixed...again!
Oh, it's "back-door" QE, alright -- the only question is whose "back door" does it get rammed up?
(HINT: If you're asking the question, it's you!)
So what happens when you give a skid row bum unlimited cases of Mad Dog and then you pay him a couple bucks for every bottle he finishes off?
If you can't duct it, fuck it!
In my mind the best analogy for this new scheme is a hermaphrodite trying to knock herself up.
at least they don't pretend it isn't a ponzi scheme anymore!
Irish GDP cut to 1%
This bullsht news was out a while ago and now they latch on to it??
LTRO?
Leveraged to Rob Others?
Rape works, too.
While nationwide home prices are down roughly 30 percent from their peak Nevada home prices are ...down a stunning 63 percent from the peak reached five years ago on November 2006.
...and still dropping...
http://www.doctorhousingbubble.com/las-vegas-looks-to-california-for-hom...
how are rents holding up?
That is a good question.... in 2011 it was a period with economical and financial recension. yacht charter in Mallorca
To me a 3 yr repo just seems ridiculous. Also, the ECB will extend this program, or do another LTRO, as the 3 year anniversary approaches. ECB lending to banks to buy sovereigns to post as collateral at the ECB is a fucking joke. Disclaimer: the details of ponzinomics are hazy so don't hold me to anything I said.
Money laundering.
Counterfeiting.
EweRow with Squid in the water App:
http://childrenstech.com/files/2010/07/baabaa.png
Using basic math, publicly available data, and sound reasoning, Kyle Bass has pointed out in numerous interviews that all of these complex machinations are hopeless and often "sophomoric" attempts as he put it to resolve a debt-based crisis that can only have two resolutions, one which is extremely painful and one that is totally catastrophic. And since politicians always want to kick the can down the road and avoid the correct but painful choices, he thinks as I do that the second route, the catastrophic one, is the the one that will be forced by the bond market and that the road the can is being kicked down has nearly reached its end.
...(unless the ECB is providing all this money without variation margin).
As long as the perception exists that the ECB will be there with more money at WHATEVER margin and WHATEVER maturity, then this entire argument is academic.
Key is that ECB is monetizing, they're just doing it incrementally AND in such a way that the banks who are doing their dirty work for them will be more easily identified.
Wouldn't worry about margin. The ECB will wave that at the first sign of trouble.
When i tell my clients what is happening they give me this wierd look like i'm some sort of idiot.
I've gotten a lot of that too.
So has CHM:
http://www.oftwominds.com/blogdec11/tin-foil-hat12-11.html
What seems missing in the above analysis of what European banks estimate will be smart to do ...
Is the fact that insolvent essentially bankrupt banks will do what they are told, to get their liquidity fix, to survive one more week or month or day.
If it's the choice between buying long-term Spanish and Italian bonds, or the EU authorities letting them go under, banks will buy the bonds.
That might be the programme.
That's all banks then, isn't it?
Isn't the news ESM fire wall supposed to protect the new bonds, awaiting fiscal discipline being put in place, allowing MAYBE eurbonds to be launched in 2013 onwards, once the Euro zone has created its new legal structures and new modus operandi. That Merkozy are shoving through with brutality, and seemingly little care for the elected in each country, if the presentation of ESM made here on other thread has ANY semblence with reality when it gets finally installed officially. We will have to monitor the due process on ESM creation, to ensure its fair and under democratic control of this dumb EU parliament that has no teeth upto now!
Doesn't this ignore the implicit cap on the ECB's funding abilities anyway? I mean if they could simply monetize the debt of these countries they would have just done it directly, rather than inject a middleman (the banks) in the transaction and call it something different, right???
Peter remember they hafta try and MAKE MONEY too rather than burn the furniture RISK MANAGEMENT style - the banks will do the carry trade and will call the 3yr operation RP to maturity for balance sheet purposes , the USD will weaken as a reuslt of repatriation bid coming out of EUR and all will be fixed...for about 15 minutes when some asshole gets his leverage wrong.
BTW this trade is the same as funding your bank by selling Sov CDs it will be done...
so, do I have this right...
ECB (aka sovereigns) liquify banks by buying already issued debt of sovereigns
Banks use liquidity to improve risk profile by reducing debt exposure while likely minimizing new loan risk
sovereigns will expect at some point that it will be "their turn" and "restabilized" banks will buy new bonds
Banks will decide it is not in their interest to buy new bonds
Sovereigns will have to decide answer to question "why do they have banks again???"
Sovereigns must force something to happen bank wise or disintegrate/reshuffle/reintegrate
is this a reasonable sequence?
listen - they can deleverage or they can buy those bonds Which are actually good - 3% is puny, ofc., but it's 300% of 1%. Everything has crap return now and... you have to get some carry from somewhere if you want to pay the bills. Ok, the risks are huge, but the risks are huge everywhere. You can park at ECB, but that'll just slowly bleed you out.
and you think they'll be smart and deleverage to reduce risk... hmm, why does it sound like wishful thinking?