Did the Three-Year LTROs Really Cause Bond
Yields to Decline?
Jacob Goldfield, Will Levine,
Spencer Salovaara
LTRO
Collateralized, daily variation margin, floating rate, non-fixed haircut loan from the ECB.
[1] http://www.ft.com/intl/cms/s/0/87157274-4676-11e1-89a8-00144feabdc0.html#axzz1raGTF6XO
[2] http://www.reuters.com/article/2012/01/27/europe-banks-funding-idUSL5E8CR1UV20120127
[3] http://www.concertedaction.com/2012/01/19/bidding-behaviour-in-the-eurosystems-december-3-year-ltro/
Lehman Moment
“the ECB provided a flood of ultra-cheap, long term cash just four days
before Christmas… ‘[i]t is a game changer its taken away the risk of
funding for the banks and given the market some confidence,’ said a
senior banker at a European bank.”[2]
“…the consensus is that the ECB’s 489bn three-year loan liquidity shot
last month has averted a credit crunch for the region’s banks… [t]he
LTRO, Morgan Stanley estimates, has helped Spanish and Italian banks
meet between 50 and 150 percent of their 2012 pre-funding needs.”[1]
“…in the first quarter of this year, more than €200 billion of bank
bonds fall due. (The LTRO) prevented a potentially major funding
constraint for our banking system.”[3]
Stress Rises in Italy
•
“It’s a very serious situation. There’s one scandalous episode after another, there’s the economic crisis, we’re being
observed very critically by the world at large… [b]ut as long as Berlusconi can hold his majority together in parliament,
the situation remains, unless there is some outside shock from the bond markets or something similar.” Renato
Mannheimer, one of Italy’s leading pollsters.
Cohesion is Strained
Contempt Is a Bad Sign
November – Government Change, Confusion
•
•
•
•
Berlusconi resigns, or not. Returning, or not.
Broad-based calls for unlimited ECB buying as the only solution but ECB resists.
Parties delay support, rates rise, ECB resists buying
Parties approve complete cabinet, Monti says serious budget announcement Dec
5.
Monti Passes
LTROReform
Market Reaction to Budget
Announcement
•
•
•
December 4: Monti details specific reform package (including pension reforms)
“The Berlusconi government was all about jokes and personalities,” Mr. Bagnoli said, “and they didn’t always seem to
know what they were talking about.”
For a long time, he concluded, Italy “had a government that was detached and out of touch. This is the opposite, and it
has become the symbol of the moment.”
LTRO
• High rates create a crisis atmosphere which leads to change
• ECB: magnificent inaction
Bank CDS
MRO + LTRO: Collateralized ECB
Financing
•
13-month LTRO announced Oct 6, superseded by 3-yr LTRO announced Dec 8, both scheduled for
same date, Dec 21
–
•
MRO: weekly, one-week, collateralized, Single List haircut, daily margin.
–
•
No fixed haircut: Haircuts in LTRO change when Single List changes.
Floating Rate (Undefined)
Why not just do rolling MROs?
–
•
Main instrument for monetary policy.
3 yr-LTRO same as MRO
–
–
•
Hard to have a short-run financing problem solved by an identical overlapping 3-yr LTRO but not by the 1-yr
Full allocation since 2008, guaranteed to July 2012, so far.
MRO could become fixed allocation.
–
–
Assess probability assuming 3-yr LTRO not done
If fixed allocation is low then MRO rate rises which is the LTRO rate.
•
•
•
•
•
If LTRO is average of minimum accepted bid then the advantage is c. .2%, assuming historical auction mechanism choice.
If LTRO is average of min bid rate or MRO fixed rate, as applicable, then advantage is c. .2%+marginal rate-min bid rate.
(Except for pathological cases)
MLF: 1%; stigma or reverse stigma
.2% x € 500bn = € 1 bn / yr
MRO is short-term repo, but LTRO is not long-term repo
LTRO Symbol
MRO fixed allocation auction cost
Risks to Banks, Some Systemic
• Subordination of unsecured debt; subordination spiral risk; systemic; Martin
Schmalz spiral
• Need to fund losses, eg Spain purchases since the LTRO announcement; margin
spiral systemic
• Private repo often < MRO rate. Can’t get out for a yr if do LTRO.
Why the high uptake?
• NCB nagging?
• Reverse stigma (which grows from Dec)
• End of Feb is low stress, yet net uptake
(adjusted for Greece ELA) is 75% larger.
• Chasing the bond market
Bond Buying by Banks
• Italian banks started with c. 15% of outstanding Italian
bonds.
• Standard market reaction to news of slow moving noneconomic demand (NCB nagging) is to rise before it
and then sell to it.
• Looks like holders of Italian bonds, except banks, sold
significantly more than Italy net sold; not counting
shorting
• Possibly pushed banks into bonds positions
•
Moved bonds to diabolical loop holders
• Second LTRO net uptake, adjusted for Greece ELA,
appears to be 1.75x first LTRO, despite stress
reduction.
13 Month LTRO and 2012 Fire Sales
and Failures
• €200bn of bank debt coming due in Q1 2012
• Fire sales and bank failures in early 2012
foreseen.
• Since it was in place Oct 6, even the 13-month
LTRO can't be the solution to whatever ailed the
market in November, or October,
• Another benefit available under the 13-month
LTRO: Italian banks issued € 40bn <1 yr bonds
Dec 2011 and used LTRO. (Even Monti bonds
were 1-yr LTRO eligible).
Evidence from 1-yr Bond?
• LTRO coverage started Oct 6
• Goes to higher levels, despite enormous “arbitrage”
and declines more than any other maturity
• Possible intepretation: prob(near-term default)
Italy yield curves
3 yr to 4 yr very flat
Private Repo Market Exists
• Private repo in Dec declines as much as LTRO
net add: ~ € 200bn. Mar repo unavailable.
Repo Borrowing thru Feb-12 (eur millions)
2500000
2000000
1500000
ECB Repo
1000000
500000
0
Private Repo
Other Suggested LTRO Benefits /
Dollar Funding
• Dollar Funding Nov 30: 50bps
– First of monthly 3-month auctions was c. €50bn,
so c. €65mn
• Regulatory Benefit
– 2018
– Change the regs
• Accounting benefit
– Goes the wrong way
• Coordination Signal
Cost of Misunderstanding the Effect
LTRO
• Undermines reform
– Misattributing the cause of the rate decline saps
governments of energy and political capital
• Raises probability of repetition during future
stress
• Causes unnecessary intra-Eurosystem discord
– Conservation of happiness principle
• Credibility
Risks of Too Much ECB Financing
• Intensifies diabolical loop if used to buy
government bonds
•
•
•
•
Systemic subordination spiral
Systemic margin spiral
Tends to raise Target2 (yet another spiral)
Reduced or Enhanced Tail Risk?
Why Initial Interest?
• Central bank observations of liquidity as a
problem or solution are sometimes incorrect
(see Bernanke speech, April 13, 2012)
• Central banks subject to Maslow’s Law of the
Instrument: liquidity
Glossary
• Maslow’s Law of the Instrument
(Maslow, A. The
Psychology of Science, 1966)
– If all you have is a hammer then everything tends to
look like a nail.
• Market/Shmarket; n. the doctrine that
pessimistic market prices are never related to
fundamentals because of the bad equilibrium
liquidity self-fulfilling-prophesy spiral.
– Practitioners are called spirologists
– see Fundamental/Shmundamental
Glossary
• Post Hoc Ergo Propter Hoc; the logical
fallacy of succession implies causation
Glossary
• Ante Hoc Ergo Propter Hoc: new logical
fallacy: preceding implies causation
Email Me
• Jacob @ antehoc.com
Unused Slides
Draghi & the SMP
8
25000
Italy Sov. 2 Year (bps LHS)
Trichet responds
to crisis in Spain
and Italy w/ bond
purchases
7
Spain Sov. 2 Year (bps LHS)
SMP Stock (eur millions RHS)
20000
6
5
15000
4
10000
3
2
5000
1
0
1/7/11
2/7/11
3/7/11
4/7/11
5/7/11
6/7/11
7/7/11
8/7/11
9/7/11
10/7/11
11/7/11 12/7/11
Nov. 1 - Mario
takes helm at
ECB
1/7/12
2/7/12
and refuses to respond to
heightened stress with more
buying
0
3/7/12
Significant Government Change in Italy
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September 7, 2011: “It’s a very serious situation,” said Renato
Mannheimer, one of Italy’s leading pollsters, whose regular survey in the
Corriere della Sera newspaper this weekend showed 8 out of 10 Italians
opposed to the government and a similar number critical of the center left
opposition. There’s one scandalous episode after another, there’s the
economic crisis, we’re being observed very critically by the world at large
and there’s generalized distrust of the political class… [b]ut as long as
Berlusconi can hold his majority together in parliament, the situation
remains, unless there is some outside shock from the bond markets or
something similar.”
October 23, 2011 Berlusconi mocked by French and German leaders:
“[w]hen asked at a press conference if [Berlusconi] had reassured them
about his action to reduce his country’s debt level, Ms. Merkel and Mr.
Sarkozy looked at each other with wry smiles, casting their eyes to the
ceiling.” 10.23.11 http://www.ft.com/intl/cms/s/0/30bc980a-fd95-11e0b6d9-00144feabdc0.html#axzz1bkjvzBc8
October 26, 2011 “Italian MPs in fist-fight over pensions” The Telegraph
10.26.2011
http://www.telegraph.co.uk/finance/financialcrisis/8851408/Italian-MPs-infist-fight-over-pensions.html
November 9, 2011 “[We] have long argued that Mr Berlusconi was unfit to
govern, but even we have been shocked by how, as the euro crisis drew
closer to Italy, he partied and politicked, brushing off the need for reform.”
http://www.economist.com/node/21538161
Italy Peak Crisis
•
•
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November 8—12: Berlusconi loses parliamentary majority, pledges to leave office, resigns
November 13 – 17: Monti sworn in, announces generic reforms, wins confidence vote, but Berlusconi waiting for Monti to
trip up
November 25: Italian yields hit highs. “Having placed their faith in the former economics professor and his unelected team of
technocrats…. Italians are getting a little nervous… there is still no clarity on Mr. Monti’s planned emergency measures.”
http://www.ft.com/intl/cms/s/0/4558dd5e-177c-11e1-b20e-00144feabdc0.html#axzz1sFYOM4js
Glossary
•
Maslow’s Law of the Instrument
–
(Maslow, A. The Psychology of Science, 1966)
If all you have is a hammer then everything tends to look like a nail.
•
Post Hoc Ergo Propter Hoc; the logical fallacy of succession implies causation
•
Ante Hoc Ergo Propter Hoc: new logical fallacy: preceding implies causation
–
•
Actual LTRO graph
Market/Shmarket; n. the doctrine that pessimistic market prices are never related to fundamentals
because of the bad equilibrium liquidity self-fulfilling-prophesy spiral.
–
–
Practitioners are called spirologists
see Fundamental/Shmundamental