Banco de Ponzi

by Peter Tchir, TF Market Advisors

Ok, I’m bored of basically saying the same thing and you are probably bored of hearing and reading the same thing, so let’s do something different.

Let’s prove that solvency = liquidity.

Yes, I am that bored today. I’m nervous about being long, but my thesis that Germany finally did the work on what a Grexit might mean and is scared to death and will play nice remains intact. That the JPM whale trade unwind put a huge strain on the market and is over and in fact calming down remains in place. That Bernanke has been pretty blatantly obvious about what he wants to do and what it would take to get him to act, and if not there yet, we are certainly darn close. So I will leave my risk on view alone.

So how can solvency = liquidity? Everything we know says that just isn’t possible? Well maybe it doesn’t but it can come close when you have participants who not only don’t care about risk, but also can’t be priced out of the market.

“Craziest” Way to Use the FROB bailout money

Make €35 billion of CoCo investments at 8.5%. These should go to better banks and can be made in conjunction with equity infusions. The carry on these positions would roughly cover the 3% rate on the entire €100 billion. Normally I wouldn’t worry about carry, but this would make the entire FROB deal “budget neutral”.

Make €40 billion of equity investments. Wipe out existing shareholders as necessary, but get real value and inject real capital. The €75 billion of CoCo and equity investments is probably a bit lite, but should be in the ballpark of what is need to stabilize the weaker banks.

Then create Banco de Ponzi.

Banco de Ponzi

Welcome to the “Banco de Ponzi.” As you create this entity it is helpful if you listen to “Hotel California” to get in the right frame of mind.

Take the remaining €25 billion of FROB money and establish a new bank with that as its equity capital.

Immediately get a commitment from the ECB to let this bank tap an LTRO facility – since they missed the first one. With a “modest” leverage ratio of 12, have Banco de Ponzi buy every remaining Spanish bond.

There are “only” €532 billion of SPGB’s and SPAIN bonds outstanding. T-bills and ICO’s make up the rest.

What is the “free float” on the €532 billion? I’m assuming the ECB owns about €50 billion from their ECB intervention. I’m assuming Spanish banks, which own a mixture of these and t-bills, probably have close to €100 billion on their books. Throw in another €100 billion tucked away in insurance companies, and the amount of SPGB’s that are in trading books and freely traded, is probably about €300 billion or less.

What would happen if Banco de Ponzi bought all these remaining bonds with their cheap LTRO money? What if Banco de Ponzi refused to lend them and all other Spanish banks and Insurance companies were told that you can’t lend the bonds. Where would the bonds trade?

Right now Banco de Ponzi could accumulate the bonds at a great average yield. Let’s say 5.5%. If they are funding at 1% via LTRO, that is roughly 4.5% of net income per annum (not exactly true, since some of yield is the pull to par affect of buying bonds at a discount, but good enough for now).

The Banco would be booking €13.5 billion in income per annum (maybe a bit less after you pay the 3 employees necessary to run this thing). A nice 54% return on equity.

The Banco and ECB could enter into a nice “evergreen” facility on the LTRO where Banco continues to roll over maturing Spanish debt into new bonds and the ECB agrees to provide more LTRO whenever it is needed.

Spain doesn’t care about initial yields that Banco accumulates the portfolio at since coupons are locked in, but would love the rolls to occur at much smaller spreads to the LTRO funding over time.

A stupid and farcical plan, but I do think the EU is looking for ways to force more and more bonds into hold to maturity accounts, and as stupid as the plan sounds, I’m not sure how different it is from the Fed’s QE and Operation Twist Programs?

Is Banco de Ponzi just a synthetic was to create the relationship the Fed and Treasury currently have?

Laugh or Cry, Nothing has Changed

Seriously, we are still running through the same scenarios that we have been for the past few days, few weeks, and possibly even a few months. The “we can’t be here because nothing has changed” crowd are all right to some extent. How much has changed since we closed at 1278 on June 1^st? How much has changed since we closed at 1,406 on May 1^st? I continue to think the May 11^th, post JPM announcement, post Greek election, post slowing growth (but pre disastrous growth) data is about the right place. I remain long for the reasons that I’ve mentioned for awhile, but am small as continue to believe that we see high volatility, and if the EU manages to mess up the Spanish bailout, then we would be down 5% or more in a heartbeat.

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