Thursday, October 20, 2011
OK, we said we wouldn't get sucked into the Euro guessing game, but unfortunately a stream of EFSF headlines have tweaked our interest. Weak willed we are.
*EFSF TO BE ABLE TO BUY BONDS ON SECONDARY MARKET IF EURO ZONE COUNTRY HAS SUSTAINABLE DEBT, RESPECTS DEFICIT REDUCTION COMMITMENTS, HAS SUSTAINABLE C/A POSITION - GUIDELINES DOCUMENT
*EFSF TO BE ABLE TO BUY BONDS ON SECONDARY MARKET IF EURO ZONE COUNTRY HAS NO BANK SOLVENCY PROBLEMS, HAS TRACK RECORD OF REASONABLE BORROWING COSTS -GUIDELINES DOCUMENT
*EFSF TO BE ABLE TO BUY BONDS ON SECONDARY MARKET IF EURO ZONE COUNTRY MAKES A REQUEST, ECB AND EURO ZONE DEPUTY FINMINS AGREE-GUIDELINES DOCUMENT
*EUROPEAN COMMISSION, ECB WOULD PREPARE AGREEMENT WITH EUROZONE COUNTRY IN 1-2 DAYS SPECIFYING HOW LONG SECONDARY MKT PURCHASES WOULD TAKE PLACE AND FISCAL ADJUSTMENT AND REFORMS IN RETURN - GUIDELINES DOCUMENT
*AMOUNT OF MONEY AVAILABLE FOR SECONDARY MARKET INTERVENTION BY EFSF WOULD BE EQUAL TO REMAINING LENDING CAPACITY OF THE BAILOUT FUND-GUIDELINES DOCUMENT
*AFTER BUYING BONDS ON SECONDARY MARKET EFSF CAN SELL THEM BACK ON THE MARKET, HOLD TO MATURITY, SELL BACK TO ISSUING SOVEREIGN OR USE BONDS FOR REPOS WITH COMMERCIAL BANKS-GUIDELINES DOCUMENT
Most of that could be said to be just an addition of some specifics to generalities that are already known. But the word that has tweaked our interest is in the last line - "REPO".
Innocuous, but in typical Euro-style, the addition of a little word could make all the difference. As we have espoused all too often leverage is the key to the success of EFSF yet the Germans are pretty adamant that the ECB should not be the source of that leverage. However, this Repo point is particularly interesting ito us, as it provides a potential backdoor mechanism to EFSF leveraging. To see this, imagine EFSF repos a BTP with a commercial bank. The EFSF is still liable for the loan vs the commercial bank regardless of the quality of the collateral (repo is right at the top of the capital structure). The commercial bank can then re-hypothecate the bond to the ECB in exchange for cash. The commercial bank no longer has the bond on its book, effectively providing leverage to the EFSF indirectly from the ECB, without it appearing like ECB leverage. TMM think that this could be a surprisingly clever way of pulling the wools over the eyes of those Germans concerned.
In the hypothetical chart below, TMM have used a separate Bank A and Bank B in order to make it a little clearer. Bank A sells BTPs to EFSF, then EFSF repos those BTPs with Bank B which in turn rehypothecates them to the ECB. The leverage provided can then give EFSF cash to inject into Europe's banks and as collateral for the much mooted "First Loss" Insurance.
There are fundamentally two problems with European debt. First, that there is too much of it. Second and more critically, the debt collector is now banging on the door. Whilst the debt hasn't gone away, fobbing off the debt collector with a story of a tangible solution may buy enough time in which to earn some money to pay him back when he next comes round. Whilst some may say that packaging up all the systemic risk in the pressure cooker of the EFSF is going to amplify the original problem, systemic risk can be reduced in the shorter term as as non-guaranteed paper is effectively removed from the market.
As far as TMM are concerned, while we need to see the details, this plan has promise and provides an interesting way to get around the German reticence to use the ECB to provide leverage. Of course, TMM could just be getting excited about something that the ECB would refuse to allow to happen - say by limiting the amount of funding the EU banks could be provided with - having banks in between as intermediaries at least makes it look less like monetisation.
TMM have been dropping like flies in the face of the latest bout of Manflu and are going to have to leave it there and grab some more Asprin.
The below clarification that the repo facility is purely for liquidity purposes means we wasted our time writing the above... Bugger!
BONDS BOUGHT BY EFSF AT PRIMARY AUCTIONS CAN BE SOLD BACK TO MARKET, HELD TO MATURITY, SOLD BACK TO SOVEREIGN OR USED FOR REPOS WITH COMMERCIAL BANKS FOR EFSF LIQUIDITY MANAGEMENT -GUIDELINES