An Important Four Letter Word

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.


UPDATE:

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

Posted by cpmppi at 12:01 PM  

19 comments:

This is not related to the post but is to trading. I need help with a trading game competition;

During this trading game, you will trade the expected value of the total of 6 cards from a normal deck of playing cards (Jack = 11, Queen = 12, King = 13, Ace = 1, eliminate Jokers). A total of 8 cards will be turned over and you will be asked to trade after each card is flipped. 2 of the cards will not count towards the total. You are encouraged to create a trading strategy to prepare for this game, and bring your strategy to the game on Friday.

I understand that I will have to trade the expected value.

TMM how do I calculate the expected value and how does it change with more cards being revealed?

REALLY NEED YOUR HELP!

Anonymous said...
12:26 PM  

how are the 2 cards that don't count chosen?

Anonymous said...
1:09 PM  

"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."

Commiserations, I had mine last week. Absolutely pathetic working myself through crates of Kleenex and loading up on all kinds of painkillers. Try Limsip, but beware if you drink it together with gobbles of painkillers. You might feel a bit oozy ;)

Interesting idea with the REPOs, it follows nicely along the lines of making it as complicated as possible.

Claus

CV said...
1:11 PM  

Breaking strain of a KitKat!!!

Thorium238 said...
1:17 PM  

Anon 1.09: Like the rest of the 6 cards, randomly. Its a poker style game. 3 cards with 3 players(including myself) and 3 on the table. After one of the cards on the table is revealed, I have to trade. And it goes on until the sum of all the cards are shown.

Anonymous said...
1:33 PM  

1. Drink 1L orange juice on waking.
2. Go to kitchen. Fill pan with 3 cups of water add 1 scooped out lemon, 3-4 cloves of garlic and a piece of ginger (all crushed in pan!). Stir in a fair bit of honey while bringing to the boil. Sip throughout day.
3. Buy Beechams POWDERS and co-codamonl 500s and take as prescribed.
4. Thank me later.

Anonymous said...
2:31 PM  

Try the Scottish remedy. [Try to channel the Fat Bastard character while doing this.]

1. Drink a bottle of Johnny Walker Black.
2. Grab a second bottle of JW Black.
3. Visit the missus, yelling "I'm dead sexy, darlin'.."
4. Wake up on couch feeling like hell.
5. Hair of the dog.
6. A massive fry-up.
7. More Aspirin.

Leftback said...
2:45 PM  

Anon. No 1, 1st ask how much do you win if you win? Is it worth the effort playing? 2nd use BLSH .always a winner.

Thanks cv.. Cpmppi has nicked all the ingredients and implements for anon.1.33 s advice.. leaving me only with only those for LB's ... ok here goes..

Polemic said...
2:58 PM  

LB,

a big fan of your ideas, would love to discuss further. If you care, please shoot email to: acceptor3 [at] gmail.com

-Equity credit

Anonymous said...
3:00 PM  

Don't complain, TMM. Gaddafi had a much worse morning than anyone.

Apparently his last words were "Don't shoot...!"

Bathos.

Leftback said...
3:36 PM  

love the chart here... Looks like they've got Andy Fastow working on this thing. They should name one of them "Death Star". Things are going to be fine over there... wink, wink, nudge, nudge.

Shane Merritt said...
3:53 PM  

Polemic: Well my iwn is the average I Bought for - the sum of all cards.

Not much of a help.

Anonymous said...
4:12 PM  

The Grauniad has just reported that Libya will bail out Greece and Italy using Gaddafi's billions.

What's that? All gone? Spent on hookahs and gold-plated faucets? Crap.

Quick, call Mangler. Time for another speech to the Reichstag on collective responsibility.

Anonymous said...
5:48 PM  

Anonymous 12:26

You need to
1) calculate the expected value of each of the eight cards that is turned up (multiply by 0.75 because a random quarter are discarded)
2) calculated the average expected value of the remaining cards not flipped, which includes the ones in the deck, also compensating for the fact that a quarter of the selected cards will be discounted
3) add the expected value of the selected cards to the average expected value of the remaining cards times the number of additional cards to be flipped.

Step 3 gives you the total expected value of the hand (before the game starts, the total expected value should be 42, ie six times the average value of the cards in the deck or 0.75 times eight times the average value of the cards in the deck)

You can build an excel spreadsheet to give you a running tally. Word of warning, I'm no mathmo. If this is for an exam or a job interview or money, caveat emptor.

Alen Mattich said...
5:53 PM  

German announcement at 1.30. Mangler cancelled her Friday announcement, they are sending out some other guy.

When pols have good news, don't they like to announce it in person? Then when it all goes pear-shaped, they send out an underling.

Merkel Cancels Speech

Leftback said...
6:19 PM  

Wouldnt the leveraged EFSF, if made active as is promoted, be the biggest heist of european tax payers and fool of politicians ever recorded? We went through a vote process in 17 countries to accept a 200 bn boost/liability, and now the EU magicians increase their respective liabilities 5 times that? Why are people not reacting? Why is it that the only country I read something official from is the second poorest country in the union?

As Germany was reportedly mulling boosting the firepower of the bailout fund to EUR1 trillion ($1.38 trillion), Radicova said Slovakia--after Estonia, the euro zone''s poorest member--does not agree with further leveraging.
"We don''t agree with any further leveraging through state guarantees. And we are not the only ones--the German Bundestag said that their guarantees are also the ceiling for them," Radicova said, referring to Slovakia''s approval of EUR7.7 billion worth of state guarantees for the EFSF.
"Leveraging of the EFSF through guarantees of states that need to cut their own deficits, isn''t possible," she added.

Anonymous said...
11:19 PM  

C says'

"Wouldnt the leveraged EFSF, if made active as is promoted, be the biggest heist of european tax payers and fool of politicians ever recorded?"

I hope so,the bigger the better.
I do hope that the Anon who asked that question understands the difference between passing some form of moral judgement on policy moves and making money from them.

If we really have to have these fools running something then at least we owe it to ourselves to derive some benefit from it.

Anonymous said...
9:25 AM  

C says'

"Wouldnt the leveraged EFSF, if made active as is promoted, be the biggest heist of european tax payers and fool of politicians ever recorded?"

I hope so,the bigger the better.
I do hope that the Anon who asked that question understands the difference between passing some form of moral judgement on policy moves and making money from them.

If we really have to have these fools running something then at least we owe it to ourselves to derive some benefit from it.

Anonymous said...
9:25 AM  

C, what I meant to say apart from highlighting the moralistic implications was that the market now has gotten ahead of itself thinking that local governments will not want to have a say in the new and improved leveraged EFSF. This is completely overlooked. Noone has on the agenda a development where 17 or so governments once again are to vote on the EFSF.

Anonymous said...
1:24 PM  

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