Cluster Family Office Blog

The Vampire Ball

Expansión reported in this article recently, that Spanish banks had set about buying debt issued by the Kingdom of Spain to «offset the decline in banking business». In other words, lending the money that the ECB is supplying in abundance and at ridiculously low rates to the Spanish government is a piece of cake – a bargain that generates «easy and safe» money.

Specifically, the calculations set out by the author are elementary: «The financial sector secures funding from European clearing houses at a rate slightly above 1% on LCH.Clearnet or on Eurex Repo, or from the European Central Bank (ECB), which currently lends to banks at 1.25%. Whether through these clearing houses – of which Caja Madrid, La Caixa, Popular, BBVA and Ceca are already members – or through the central bank, banks must pledge an asset to act as collateral for the loan. Government bonds are, in fact, among the assets most frequently used by banks for this purpose. Furthermore, the head of treasury at a Spanish bank notes that ‘the risk department of any Spanish firm facilitates the purchase of Spanish government debt over other types of assets, as it is the one they know best’. Finally, the Basel III financial reform includes, amongst its major innovations, the creation of liquidity standards. When calculating this new ratio, government debt is one of the assets considered to be the most liquid. That is why they are seeking to take advantage of an environment of very low interest rates to raise short-term funding in the repo market (repurchase agreements), at just over 1%, and purchase Spanish government debt, which yields between 2.546% and 5.353% over maturities ranging from one to ten years. In short, they raise funds at a rate well below that at which they lend to the government, enabling them to generate a substantial margin in excess of 1.5%»

In other words, an open bar in exchange for «valid» collateral, preferably Spanish government debt. What a coincidence! An exchange of favours in which, on the face of it, everyone wins… But in reality, we all lose. The strategy is worthy of Machiavelli: I, the State, need someone to keep lending me money because Mr Market doubts my creditworthiness, my budgets are in deficit, I have fallen into a deadly downward spiral of recession, and I want to postpone my bankruptcy in the eyes of the international community for as long as is politically possible (as they have been doing the little black ones who’ve already dropped out of the top ten). I therefore need large amounts of cash to keep my yields – or risk premiums – as close as possible to the German government bond benchmark. If the «private market» does not lend me enough money because I look like a zombie, my yields would skyrocket. And if that were to happen, default would be a certainty that would also affect all my creditors, including those in Germany and France. If Spain had its own central bank with the power to issue pesetas (or whatever currency), banknotes would be printed in the absence of external financing, as Argentina has been doing since its ‘corralito’ ten years ago. But unfortunately, we cannot print banknotes at will. Not even the ECB can do so, given that it is politically incorrect, illegal and clearly abusive for the EU’s central bank to underwrite the public debt of one of its members at the expense of the rest. For all these reasons, the ‘magic solution’ reached between Spain and the Eurozone, in some obscure secret meeting at the very highest levels of the EU, was as follows: that my European creditors and colleagues, with their little euro-making machine (the ECB), flood my banking system with cheap and virtually infinite liquidity (under the pretext of injecting liquidity into a system badly battered by the property bubble), so that they, in turn, can lend me all that money by buying Spanish sovereign debt. But why should the banks use that money to buy my government debt rather than put it to some other use? Well, a favour is repaid with a favour. All it takes is a gentle nudge in that direction, by ensuring that sovereign debt is the ECB’s preferred collateral – or, to put it another way, by imposing conditions or requiring other forms of collateral for the exchange of money for worthless pieces of paper. A word to the wise—those who are allowed to falsify their accounts through corrupt valuations of repossessed properties—needs no further explanation.

The State cares very little about the fact that, as a result, the liquidity flooding the market does not flow towards businesses, towards the country’s real economy, the business community and their impoverished pockets. The only thing that matters to it is that it flows towards the refinancing of sovereign debt to avert the imminent bankruptcy of the state, as has happened in Greece, Ireland or Portugal. Because, amongst other reasons, Spain is not bailable. Civil society in wealthy Europe would rebel against the bailout figures required by an economy as large as Spain’s. Our country must be kept afloat through covert bailouts which, moreover, inject easy profits into the balance sheets of our banking system, which in turn are pure lifeblood for the Spanish financial system itself. Two birds with one stone – or rather, two vultures.

It’s like a macabre joke in which one bankrupt person says to another: ‘Take some money from the free-for-all and lend it to me; I’ll pay you a spread of 1.5%.’ That way, the two bankrupt parties look less bankrupt, whilst the ‘free bar’ keeps churning out banknotes, which in turn brings us all closer to bankruptcy – or at least dramatically impoverishes the non-bankrupt, wealthy northerners who share the ECB with us. I know many of you will say that those rich people are richer thanks to everything they export to us in their own currency. But everything has its limits, and very soon they’ll realise that the burden of the peripheral crisis and its downward spiral no longer outweighs the profits they’ve made.

This process is, of course, subject to enormous inertia. And we do not see its effects until it is already too late to correct mistakes. But conceptually, we must not forget that our beloved yet much-hated Mr Market does not generate risk premiums without good reason. It does not come for free to buy higher sovereign yields with money subsidised at 1 or 1.25%. Spanish banks are doing nothing but buying risk. Yes, yes, you’ve read that right – even more risk than it has already accumulated in its rotten mortgages to property developers and private individuals in the a car and a house at the age of 35. The situation is so Kafkaesque that, whilst accounting tricks keep the value of repossessed properties afloat on their balance sheets, the banks are delighted to be improving their dire financial position with «easy money». Lucrative profits of give and take that, in reality, what they are doing is increasing their insolvency by taking on country risk: Spain. The spiral is so absurd that the circle closes with the ‘free-for-all’ itself, which is nothing more than the transfer, in turn, of the risk assumed by the banks to the ECB in the form of guarantees or collateral. In other words, the ECB is effectively buying Spanish risk via an intermediary (the Spanish banking sector), which it is in its interest to subsidise with windfalls so that it does not go bust and spread panic with a highly contagious ‘corralito’. And at present, Spain is not collapsing thanks to this deeply vicious cycle, in which the ECB shoulders Spanish risk whilst, of course, paying the ‘revolutionary tax’ of keeping the Spanish banking sector afloat in turn.

Wouldn’t it have been simpler, more transparent and more ethical to have started there? Well, yes, but for the economically sound part of Europe to assume responsibility for the sovereign defaults of the entire European periphery is, at present, politically unacceptable as well as illegal. Not only for that reason, but also because it could lead to greater apathy and laxity in the affluent and unproductive societies, and in the electioneering governments of a periphery that should never have believed itself capable of sharing a currency with much more robust economies. Yet it seems to have suited us all to pretend that no one is supporting anyone else and that everyone is fending for themselves, with no bankruptcy whatsoever. What’s more, when a couple of years ago some of us denounced this extreme and unsustainable situation—the consequences of which are now becoming obvious—we were branded as doomsayers, anti-patriots, Eurosceptics, or who knows how many other things. For most people, back in 2008, 2009 and 2010, the evidence we presented was regarded as politically incorrect and economically unfounded nonsense.

In short, it is a Vampire Ball, reminiscent of that in Polanski’s brilliant film. An obvious yet macabre link, denied to the point of absurdity, in which the Spanish state and the Spanish banking sector are so intertwined that not even death (default) can separate them. Either Europe bails them out and they carry on hand in hand until they have purged their interdependencies (by having Mr Market take over the role of lender currently played by the Spanish banking system), or they both go under.

Germany is allowing the ECB, with a noose around its neck, to recklessly try on a pair of «PIIGS» concrete shoes on the edge of the cliff. And as things stand, it is this very same noose that links Germany’s neck to that of the ECB and the rest of the countries on the European periphery. For this reason, the high value of the Bundesbond and the «Bundescurrency’ – that is, the euro – seems unsustainable for much longer, unless the noose linking Germany to the ECB and the peripheral ‘concrete shoes’ is made of paper (and the heavy hands of Mr Market are aware of this). At this point, it is worth repeating what we discussed in our previous article entitled ‘Flats at 1970s prices«: As long as the rope isn’t made of paper, perhaps we should make the most of it «...in such a clever way that we find ourselves holding a currency, in exchange for which the world gives us far more than it is actually worth, at least for those on the European periphery…»… and if it can be demonstrated on paper, all the more so.

To make matters worse, DSK Officially, something very similar to what happened in Julian Assange, leaving out of action. And the G20 is in an uproar, arguing over the placement of Lagarde in his post, just in case the IMF leave the ECB in the lurch and make its role as sucker in this crisis, in the eyes of the wealthiest Europeans. Everyone’s rallying against the threat of insolvency… well, until someone actually gets burnt, of course.

«Few see who we really are, but everyone sees what we appear to be»

Niccolò Machiavelli (1469–1527)

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