Looks like the banks are stocking up.....

Generali

.....to get into the next round of the bailout.

The ECB starts something called the LTRO on Wednesday. That is where they will lend banks (not you or me of course) money at very low rates of interest taking 'quality' collateral such as Spanish Government debt as security.

The 'R' bit of LTRO stands for 'Repo'. Now the way that a Repo trade works is that you put down a bond (for example) as collateral to borrow money, paying a rate of interest. However, the bond is still yours despite it being held as collateral so you are entitled to the coupon (interest payments) that flow from it.

So what is a poor, down-on-his-heels banker to do in this situation? Why buy up high-yielding bonds and use them as collateral to borrow money from the ECB.of course. That way they get to collect the difference in interest between what the Spanish (Irish or Italian) Government is paying them and what they pay to the ECB!

That should have the effect of pushing up demand for crap bonds, reducing the rate of interest crap Governments have to pay.

Now of course you could just dismiss this as speculation and even as conspiracy by an embittered former Investment Banker who has seen better times. But it just so happens that the Spanish Government sold some new bonds today! Happy coincidence that it is.

So what was the result?

Well the biggest part of the sale was EUR3,720,000,000 of 3 month debt sold paying a coupon of 1.735% vs the last auction of 3 month debt which paid interest of 5.110%. In that one small part of a single auction, the Spanish Government has saved over EUR30,000,000. The subsidy on that auction to the banks will be in the region of EUR8,000,000. Note that the ECB will also be accepting 'toxic debt' that is at the lower end of level 3 on a 10 point scale (A rated).

Heyman_2

Had to read it twice, ha ha :-)

So, the loser (if there is a loser) in this will be the banks though won't it? Because even though they're collecting the difference between the rates of interest, it's still not be as much as they were getting a few months ago?

I guess the risk is lower, maybe.

Masomnia

Interesting 'bail out by the back door', one wonders who bears the cost? If anyone?

If they want to get the yields down why doesn't ECB just buy more of the bonds?

Kennyboy66

Generali wrote: »

.....to get into the next round of the bailout.

The ECB starts something called the LTRO on Wednesday. That is where they will lend banks (not you or me of course) money at very low rates of interest taking 'quality' collateral such as Spanish Government debt as security.

What happens if 18 months down the line those nice Spanish bonds or Italian bonds are worth 60% of their current value because the euro has broken up ?

Will Eurozone banks be treated differently than UK ones ?

I presume the definition of "quality" does not extend to the hapless Greeks ?

chewmylegoff

Generali wrote: »

.....to get into the next round of the bailout.

The ECB starts something called the LTRO on Wednesday. That is where they will lend banks (not you or me of course) money at very low rates of interest taking 'quality' collateral such as Spanish Government debt as security.

The 'R' bit of LTRO stands for 'Repo'. Now the way that a Repo trade works is that you put down a bond (for example) as collateral to borrow money, paying a rate of interest. However, the bond is still yours despite it being held as collateral so you are entitled to the coupon (interest payments) that flow from it.

So what is a poor, down-on-his-heels banker to do in this situation? Why buy up high-yielding bonds and use them as collateral to borrow money from the ECB.of course. That way they get to collect the difference in interest between what the Spanish (Irish or Italian) Government is paying them and what they pay to the ECB!

That should have the effect of pushing up demand for crap bonds, reducing the rate of interest crap Governments have to pay.

Now of course you could just dismiss this as speculation and even as conspiracy by an embittered former Investment Banker who has seen better times. But it just so happens that the Spanish Government sold some new bonds today! Happy coincidence that it is.

So what was the result?

Well the biggest part of the sale was EUR3,720,000,000 of 3 month debt sold paying a coupon of 1.735% vs the last auction of 3 month debt which paid interest of 5.110%. In that one small part of a single auction, the Spanish Government has saved over EUR30,000,000. The subsidy on that auction to the banks will be in the region of EUR8,000,000. Note that the ECB will also be accepting 'toxic debt' that is at the lower end of level 3 on a 10 point scale (A rated).

This worked out so well for MF Global, of course!

michaels

And of course if the bonds do default who makes the loss? The banks or the ECB?!

gagahouse

michaels wrote: »

And of course if the bonds do default who makes the loss? The banks or the ECB?!

The bank if it is still solvent. If it has gone bust the ECB get's to keep the worthless collateral, so ultimately the taxpayer.

It's a taxpayer underwritten subsidy made possible by the ECB accepting sub-prime collateral which helps banks and the governments to finance their deficits at the same time.

gagahouse

Kennyboy66 wrote: »

What happens if 18 months down the line those nice Spanish bonds or Italian bonds are worth 60% of their current value because the euro has broken up ?

Will Eurozone banks be treated differently than UK ones ?

I presume the definition of "quality" does not extend to the hapless Greeks ?

Depends what the banks do, if they sell those bonds on their return from the ECB they crystallize the loss immediately. Or they could hold them to maturity and get them redeemed at par from the issuer (unlikely in a Euro breakup scenario).

That said, the ECB has already loosened its collateral requirements on sovereign debt and
continues to accept Greek debt which is widely expected to take significant write downs.
Given the widely reported ‘collateral crunch’ in the eurozone these mechanisms may help.

http://www.openeurope.org.uk/research/ECBlenderoflastresort.pdf

Wookster

This is the ECB acting as a de-facto lender of last resort.

This course of action only serves to add another layer to the pack of cards: wind blows and they all fall down.

Joe_Bloggs

The talk of repo and wookster's punk reference led me to reminisce on the film 'Repo Man' . Check it out if you can.

J_B.
Never mind the quality feel the width.

Generali

Kennyboy66 wrote: »

What happens if 18 months down the line those nice Spanish bonds or Italian bonds are worth 60% of their current value because the euro has broken up ?

Will Eurozone banks be treated differently than UK ones ?

I presume the definition of "quality" does not extend to the hapless Greeks ?

The term quality doesn't include Greek debt thankfully.

In theory, all creditors in a class should be treated the same. Increasingly that isn't happening.