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Thursday, 19 October 2017

A taxpayer-funded pyramid scheme

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Anthony Peters, SwissInvest Strategist

It’s Monday and it’s D Day – or at least it is with respect to the €130bn bail-out package for Greece as it is today that the eurozone finance ministers are expected to ratify the deal following the Greek cabinet’s approval of all the cuts required to meet the conditions which have been set by the putative lenders – or should that not perhaps read “donors”?

The deal is sort of signed off but the private lenders are still eyeing up the ECB with suspicion as they have to ask themselves whether the new translation out of Latin of “pari passu” is “zat meanz you but it does not mean uz” when it comes to the write downs which will be required in order to meet the restructuring objectives.

If one government agency lends the money cheaply which the banks subsequently spend on buying the debt of another government agency at a higher rate, we have nothing but a taxpayer funded pyramid scheme

The ECB has been playing ducks and drakes with the markets when it comes to deciding whether it will have to throw its holdings of Greek bonds into the exchange pot or not. However, last week, a raft of national central banks agreed to have their holdings treated as “private” in order to help to carry the deal over the line.

I don’t know how many of them still hold significant positions in Greek guvvies – I have it from a very reliable source that at least one non-eurozone central bank shelled out all of its paper through the back-door months ago – but the fact that they are prepared to play along just goes to prove how worried they are that the deal may yet fail. When it comes to the so called “hold-out investors”, none features more prominently that the ECB itself. Not without reason, I hasten to add.

Although we professionals are aware of this, the biggest amount of bailing out of the banking system is not being done through the capital injections but by way of the near zero rate monetary policy which the ECB, the Fed, the BoE and the BoJ are offering.

Ten-year Bunds, Treasuries and Gilts may all be wrapped around 2%, but with funding rates at diddly squat and the risk of tightening in the near term as good as non-existent, banks are being invited to rebuild their capital bases for free.

This is not a new game and the Fed did it very successfully during the S&L crisis at the beginning of the 90s. Some would argue that without the risk-free carry trade, there would be no more Citibank. Some would go one step further and contend – and not entirely without reason – that the low Fed funds rate of that period was instituted for no other purpose than to keep Citi from going under with all the concomitant systemic risks.

However, if one government agency lends the money cheaply which the banks subsequently spend on buying the debt of another government agency at a higher rate, we have nothing but a taxpayer funded pyramid scheme. The beauty is that north of 99% of all taxpayers affected haven’t got a clue that they are doing it. This is probably the simplest way transferring the banks’ problems onto the public sector balance sheet and, look, no hands!

Obfuscate or litigate

Taxpayers and voters are about to be topped and tailed. It is understandable that the ECB doesn’t think that it needs to write down its €55bn nominal of Greek debt for if it does, then the €130bn loan by eurozone partners grows by the 70% odd which the write down would cost. That could be around another €38bn though probably a lot less seeing as that the ECB did not pay par for too much of the paper which it owns. So it has the choice of either significantly increasing the cost of the Greek rescue to the rest of the eurozone or being prepared to face the inevitable litigation which will follow if it opts to seek special treatment of its holdings.

Which brings us back to the rule of law, the key principle of which is that the state is subject to the same laws as are the citizens. Should the separate treatment of private and public creditors be brought before the judges, I suspect that they will be hard pressed to hold in favour of the authorities. My feeling is that the ECB officials are patently aware that they are playing with fire but they really don’t have much of an alternative.

Any agreement today to disburse funds to Athens only kicks the Greek default into the long grass. We know that. They know that. The Greeks know that. However, France has got an election and Sarko needs to avoid Greece from failing hic et nunc and his most recent attempts to present himself as the grand statesman turning to dust along with his poll ratings.

All the while, the agencies continue to downgrade sovereign and bank credits across Europe with gay abandon but markets are not showing signs of giving a fig. Are the agencies closing the gate after the horse has bolted or are they issuing a stark warning into an investment environment which is simply bored with being bearish?

The economic numbers – the leading ones – are certainly looking brighter but Accountancy 1.0.1 taught us that business failures rise sharply after the turn in the economic cycle. Can banks and governments also become victims of overtrading? An interesting thought, isn’t it?

Meanwhile, on a different note, I hear that the police have now also found US$7trn of US government bonds hidden in a vault in Maiden Lane. The New York Police Department report that they are looking for two suspects known as Big Ben and Tiny Tim. 

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