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Sunday, 17 December 2017

Zen and the art of market maintenance

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SwissInvest strategist Anthony Peters takes issue with government debt auctions

Anthony Peters, SwissInvest Strategist

ARE DEBT AUCTIONS really still the way forward for sovereign borrowers or are we beginning to see something of a revisionist approach to the way governments fund themselves?

There is no doubt that the decision by the Spanish authorities to tap their benchmark 10-year bond, the 5.85% January 2022, through a syndicate rather than through an auction marks a shift in the overall approach to raising cash.

Let’s face it, the Americans brought us the auction process and, during the period of European convergence, government bond auctions developed into something of a virility test where even the smallest could display their six-packs. However, the financial crisis has shown that even in the most evidently liquid of markets, transparency isn’t all it’s cracked up to be.

It may be slightly fatuous to return to that fateful day in January of 2010 when the Greek five-year auction flopped, marking the launch of what has become known as the European Sovereign Debt Crisis. Auctions work fine in a seller’s market but when the powers shift back towards the buyer, they ruthlessly expose any weakness in the demand structure.

I am reminded of Bertolt Brecht. “Sometime they’ll give a war and nobody will come,” says Brecht, quoting Carl Sandburg, and then goes on: “He who stays at home when the fight begins and who lets others fight for his causes must beware. For he who has not shared in the fight will only share the defeat. Avoiding the fight, by him who wishes to avoid the fight, is like fighting for the enemy for him who has not fought for his own cause.”

What made that day so very painful was not that the auction flopped – many have – but the childish response that followed from the Greek side and that led to a series of quite unbelievable utterances from the political stage with respect to the elected authorities’ unshakable conviction that buying their bonds was some sort of civic duty.

BUT AS WE pick over the carcasses of once-proud public-sector loan books, we need to do some thinking. The very fact that government bond business was taken out of the bond department and lumped into “rates” demonstrates that even the banks bought into the misconception that lending to a government was an interest-rate decision and had nothing to do with credit.

By reverting to the more conservative process of offering bonds at a reopening through a sensibly managed syndicate, the Spanish Treasury has moved us forward

How one can lend to anyone, even a government, without recognising it as a lending process has always had me scratching my head. Alas, what was I to know – the guys who took those decisions had a zero more on the comp cheque than I did and therefore they had to be right, didn’t they?

In the same way, they all auctioned off their debt in the fashion of Uncle Sam. However, the fear and loathing that has been attached to some of the auctions of late, especially those of Italy and Spain, has shown that transparency and market forces are not always what they are thought to be.

The choice by the Spanish to swap transparency for stability in the money-raising process is highly laudable at a time when the market for its paper was stressed and one that I hope will be repeated. It brought them a very nifty €4bn.

THERE HAS BEEN much in the past years that has demonstrated that the European government markets aren’t quite as grown up as they’d like to be. The issues surrounding Citigroup and its exposure of the EuroMTS system with its perceived liquidity as an exercise in smoke and mirrors in 2005 should not be forgotten.

More to the point, the way the traders in question were hung out to dry for demonstrating that the quote-driven platform was beset with weaknesses that those in charge did not want to know about was an early lesson in what happens to those who speak the unspeakable and that heretics will be burnt at the stake.

By taking a step back in time and by reverting to the more conservative process of offering bonds at a reopening through a sensibly managed syndicate, the Spanish Treasury has moved us forward in terms of reducing randomness and limiting the risk of primary dealers.

The UK’s Debt Management Office has not been shy either when it comes to syndicating tap issues of ultra-long gilts and has long been aware that stuffing risk on to traders’ books does not necessarily benefit the taxpayer in the long run.

As investment banks have to adjust and adapt to the changing business environment, so do the debt agencies. Spain has led; let us see who will follow. ¡Olé!

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