A Funny Thing Happened On The Way To The LTRO

From Peter Tchir of TF Market Advisors

A Funny Thing Happened On The Way To The LTRO

I’ve taken some comfort with the LTRO.  While it won’t solve the sovereign debt crisis, or even provide much direct benefit, it does help the banks.  It helps the banks manage their balance sheet and is a clear sign that the ECB takes its role of lender of last resort to banks very seriously. 

That is all very good, but at least one part of the process strikes me as somewhere between bizarre and downright scary.

Banks in weak countries have been issuing debt, getting a government guarantee, and then posting them as collateral at the ECB.  There are examples of this for Greek banks for sure, but my understanding is it has also been occurring in Portugal and Ireland.  It is the only way banks in Greece (and the other countries) can raise money.

It always struck me as a little bizarre, but guess it was done so the ECB could justify lending the money.  I always thought it was relatively harmless, and was only adding to the risk of countries that were already in deep trouble – providing a guarantee is NOT riskless.

But it appears about €40 billion of yesterday’s LTRO was done by Italian banks that issued bonds to themselves and got a government guarantee, and then posted it to LTRO.



Here is an example of what I think happened.  Unicredit issued these bonds on the 20th.  It was by far their largest bond issuance in more than 2 years.  Nothing else in that timeframe was bigger than 2 billion.

Intesa Sanpaolo had an even bigger issue.  I’m sure there are others.

So these banks didn’t have any other collateral they could post?  Unicredit has a balance sheet approaching a €TRILLION but they had nothing they could post as collateral?

That seems strange.  Extremely strange. 

To the extent people hoped these banks would buy sovereign debt, they have actually created MORE sovereign debt.  Italy supposedly guaranteed these bonds.  Italy just increased their potential debt burden by providing this guarantee.  This is taking the All for One and One for All approach to an extreme.

I’m still somewhat constructive about what the ECB is doing, but this idea of banks issuing bonds to themselves, getting a government guarantee, and posting it as collateral at the ECB to pay for the purchase, is worrisome.  The fact that it wasn’t just one bank that did this is even more troublesome.  It is so circular, that I may be overreacting, but it certainly doesn’t pass a smell test.

The bonds I have found are all 3 month zero coupon bonds.  I am very curious why they are only 3 months.  Why not longer?   Is there something special about 3 months?  Time to decide to switch currencies? 

Why was it only Italy (or at least as far as I know was only Italy).

There is more conjecture and guesswork here than I would like, but investors need to figure out what this means.  Monti kind of rhymes with Ponzi and too many banks did this for it not to have been supported, if not directed by the government.