Thursday, 1 March 2012

LTRO, Draghi's Ponzi scheme

Mario Draghi is the governor of the ECB. LTRO stands for Long Term Repo Operation in this case 3 years as opposed to the usual 2 week or one month refinancing central banks have previously used to supply liquidity to money markets.Charles  Ponzi was a crook who  in the US in 1920 took peoples money and promised wonderful returns which were in fact paid by the subscriptions  of the later entrants.

Draghi's one trillion Euro LTRO looks a bit like a Ponzi scheme to me. European banks can deposit sovereign bonds as collateral with the ECB and get for 3 years money at 1% on the market value if their bonds less a margin, usually less than 5%. Often there is no market for these bonds but no matter the ECB will fix a price for them and lend.

What do the banks do with these bonds? Well if its 10 year Italian or Spanish they earn 5% interest roughly which is a lot more than the 1% plus a bit financing cost they have incurred. Even better they can then recycle these bonds back to the ECB in regular repos to get yet more Euros.

The Ponzi bit comes in when these banks have to find the money to pay the repo interest rate. Where do they get it from? Easy the ECB just lends them more to pay the interest rate so I suppose its really a reverse Ponzi. 

Ponzi schemes come unstuck when they run out of new mug investors. Draghi's new Ponzi will come unstuck when inflation takes off and international investors demand higher rates. About this time say 3 years away the banks will have to start repaying their LTROs but they won't have the money to do so. Over to you Signor Draghi!

So he will have postponed the day of reckoning and created an even worse crisis that will submerge Italy, Spain, Portugal and the new communist paradise of M Hollande's France.

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