Sun Oct 27th, 2013 at 07:04:03 PM EST
This caught my eye and immediately made me want to run it by the resident ET BS-busters for a comb-through.
Beppe Grillo's Blog
At first he pulled the LTRO rabbit out of his hat and then he produced two white OMT doves. In this way, Draghi has for the time being, won the two turns he's had at the gaming table of the Euro. But the game is still not finished because sooner or later, the market will call his bluff. It's these two magic tricks, the LTRO and the OMT, that for now are keeping Italy and its banks alive. For how much longer?
The first LTRO was announced in December 2011 followed by the second one in March 2012. The objective was to supply liquidity to our banks in exchange for guarantee taken to the ECB, given that the north European banks no longer trusted peripheral banks and no longer lent them money. In theory, this should have made it possible to finance the real economy: I, the ECB, am loaning you money in exchange for guarantees so that you can pass on the money in the form of loans to the SMEs and the families. In reality the real economy has seen very little of the 250 billion of LTRO money that the Italian banks got from Draghi. In fact they have reinvested nearly all that money in BTP that are giving a yield of 4.5% after having taken the ECB loan at an interest rate of 0.5%. That's roughly 10 billion in profits each year for the Italian banks in exchange for allowing the State to place its debt. In fact more than half the annual profits of the Italian banking system come from this little game: the ECB loans money to you the commercial bank and you the commercial bank loan money to your State. And the results? In the last two years the value of loans to Italian companies and families has gone down by 70 billion euro and the value of BTP government bonds being held by the banks has gone up by 190 billion euro, and now stands at 411 billion euro (more than 10% of the total value of holdings in Italian banks).
Having discovered what game is being played out, the market returned to the attack in the summer of 2012, by putting pressure on our BTPs: the central bank is the only institution that can give guarantees to the market on the solvency of the states in those places where it is buying debt by printing currency. The statute of the ECB does not allow this. But Draghi went very close to the wire, by announcing the Outright Monetary Transactions (OMT) programme in the summer of 2012. When faced with resistance from Germany, Draghi announced that the ECB is prepared to buy public debt in secondary sovereign bond markets where the bonds are due for redemption in up to three years, for those countries that happen to find difficulty in finding someone to take on their debt. This happens in exchange for rigid intervention on the part of the Troika (the IMF, the European Commission and the ECB) that is imposing reform in exchange for this help. In August 2012, no one thought that such an announcement of intentions would be enough to placate the market. At that time, there was a discussion about whether Italy should act before Spain to take the opportunity to get OMT support. What's happened in the last year tells us that Draghi has won and that for now, the market has placed its trust in the announcement without going calling the potential bluff, given that no peripheral state has had recourse to the OMT programme. Yes sure. It could be a matter of bluffing, because the German Constitutional Court has still not passed a resolution about the legitimacy of this programme. It'll do that in December.
There's nothing wrong in the fact that it is the central bank providing a guarantee for public debt. In fact, it is the right of a sovereign people and of its central bank to make use of all the tools of economic and monetary policy according to the phases of the economic cycle, including the power to "monetize" the debt by printing money. That has always been done by the FED, the Bank of England (BoE) and the Bank of Japan (BoJ) but not by the ECB. Its statute does not allow it to buy public debt but, for now, by using a semi bluff, the OMT programme has succeeded in convincing the markets that this could be possible.
Two years later, we find we have a banking system that gets its liquidity from Draghi (and not from the other banks) and then uses this to buy in BTP (and not to spend in the real economy), thus creating a vicious cycle in which the state's weakness has been transferred to the banks and only the announcement of the OMT, has, for the moment, kept the situation on its feet.
But the time that Draghi has managed to buy is not infinite: Merkel's "gong" on the OMT programme will arrive sooner or later and that day will be the last round. On that day, the Italians will be left with nothing but their underwear. Perhaps not even that.