Why Spanish,Italian and Belgian government bond markets have recovered and worrying UK liabilities

Yesterday we saw an example of a new factor in the Euro zone crisis that I discussed back on the 2nd of December. Although to be fair it is better to say that it is a new variant of a factor which has been at play in the past. Below is a link to that article


So as you have probably gathered I think we saw a clear example of this sort of “round tripping” tripping yesterday and it took place at the Spanish government bond auctions.

What happened?

Spain sold a combined 6.03 billion Euros of government bonds with maturities of January 2016, April 2020 and April 2021. Now in the current nervous environment that may seem something of an achievement in itself but it seems even more remarkable when their target was to sell only 3.5 billion Euros!

What created this sudden enthusiasm for Spanish government bonds?

The examples I gave on the second of December have something else to support them now and it is due to a new initiative at the European Central Bank. It announced at its last policy meeting that it will hold two separate three-year long-term refinancing operations and the first of these is on Tuesday.

So as long as you have collateral (Spanish government bonds are collateral) you can have as much money/liquidity at an interest-rate of 1% as you want for three years. So the 2016 bonds which were issued yesterday at a yield of 4.02% suddenly look attractive do they not. You can finance them for 1% for the first three years of their life and make just under 3% a year (there will be a “haircut” applied by the ECB).

Also existing bonds look attractive and if we look at the yield on existing 3 year maturity Spanish bonds they have fallen from 5.1% on the day of the ECB announcement to 3.57% as I type this. Suddenly the improvement in the price of these bonds does not look as good as it did before did it? Yet again risk is being moved around but the underlying issue is unchanged and taxpayers find themselves potentially on the hook yet again should this pack of cards fall down.

How might this go wrong?

If we look at the case of Greece this type of trade went on around a couple of years ago but as her situation worsened her government bond prices fell heavily and a typical price is now 20 compared with a par value of 100. In essence the danger is capital losses that may be greater than the carry or interest-rate profit. In the case of Greece they turned out to be much greater nad had led to her banks becoming zombie banks.

Does this tell us who might be doing this?

It gives us some clues. For example if you are a Spanish bank then heavy falls in Spanish government bonds might make you insolvent anyway so they might think why not have another go? After all if it works they will no doubt tell us how clever they are and award bonuses all round! So there are elements of a one-way bet here. We are back yet again to moral hazard and asymettry.

Foreign banks may also be willing to do this and ironically it may be the weaker ones who are most likely to do it on the same logic as explained above.

Never believe anything until it is officially denied

The words of Sir Humprey Appleby the apochryphal civil servant of Yes Minister fame came to mind as I read various reports yesterday that this was not really happening.

Other Countries are showing the same trend

If we look at the case of Italy her three-year bond yield has dropped from 6.6% on the day of the LTRO announcement to 5.5% as I type this. In Belgium we have seen a drop from 3.88% TO 3.05% too.

Will this affect other maturities as well?

Whilst there is not a pure arbitrage here I am sure that some will be tempted by the potentially higher returns that are on offer. For example Spanish ten-year bonds yield 1.6% more than their three year counterparts.

So the recent recovery in many peripheral Euro zone government bond markets is now easier to explain and is at the price of their taxpayers who are underwriting the offer of 1% finance at the ECB.

Where does this go wrong?

In my opinion taxpayers should be underwriting productive schemes rather than bank round-tripping. If you are offering funding at 1% why not give it to businesses which produce things?

The ECB’s balance sheet gets ever worse

Here is a theme of mine and here are my thoughts from just over a year ago (6th December 2010).

the balance sheet of Europe’s central bank looks ever riskier to me and it is quite conceivable that we could be in an era where central banks as well as private-sector banks need bailing out.

If we look at progress since then it has very heavy losses on its Greek Irish and Portuguese government bond holdings and now losses on its Italian government bond holdings to add to it. So in every sense the position is now worse. It also has a 60 billion bank covered bond portfolio which as we see nearly every day signs of an increasing bank liquidit crunch in Europe we do not need to spend too much time debating its (lack of) quality.

This is before we get to the quality of the collateral it holds…..

The ECB of course denied all this back last year before making arrangements to double its capital! As to the exact mechanism well it transfers 92% of its holdings back to the constituent national central banks and so they will be left holding the parcel should the music stop. It has always struck me as a Baldrick (of Blackadder fame) type cunning plan to send such losses to the central banks of Greece Ireland and Portugal in particular.

The Bank of France attacks the UK

Monsieur Noyer the head of the Banque de France pointed this out yesterday.

 UK has a bigger deficit, as much debt, more inflation, weaker growth than France

Apparently he also went on to point out that les ros bifs are perfidious, that the Duke of Wellington was lucky at Waterloo and that both Shakespeare and Dickens translate poorly into French and are not worth bothering with. Having learnt that his car is protected from lightening by a (Michael) Faraday cage he wants it removed and will take his own risk and he will never ever again use a microwave!

Ok,ok I have made the last paragraph up. But we seem to have entered a period which is exhibiting two flaws.

1. Central bankers are behaving like politicians

2. Whilst there is talk of co-operation in reality there is much discord which reminds me of the competitive devaluations of the 1920s and 30s. Unfortunately this is a dreadful analogy and we must hope that this stops.

The Office for National Statistics joins in

It may be for best that Monsieur Noyer was not aware of this when he gave his interview.

The net worth of the UK public sector, measured on a National Accounts basis, fell to approximately zero by the end of 2010, largely as a result of increased government bond liabilities

And it doesnt stop there.

Unfunded public service pension scheme obligations standing at £1,016 billion at 31 March 2010

Unfunded state pension obligations, which stood at £1,350 billion when last officially estimated at 31 March 2005

The WGA also identify a further range of more remote public sector contingent liabilities, some of which are unquantifiable. Those which were quantifiable amounted to over £600 billion at 31 March 2010.

So grim numbers but I do have a thought for you on them and it is that the numbers are based on asssumptions and estimates which are unreliable. So whilst the principle of the numbers above is true they are incredibly unlikely to be.

A new financial dictionary

I am setting out to compile one of these and would be interested in readers thoughts and ideas. For example the way the word “temporary” now covers any time period you choose between now and the end of recorded time.

This entry was posted in Banks, Euro zone Crisis, Eurozone, General Economics, Greek Financial Crisis, Interest rates, Quantitative Easing and Extraordinary Monetary Measures, Yield. Bookmark the permalink.
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  • Anonymous

    Shaun – for you new dictionary:

    RECOVERY (noun)  = a slight blip in a general downward trend
    TO MERVYN (verb) = to meander in a meaningless and vacillating manner
    QE (abbreviation) = quality evaporating 

  • http://www.facebook.com/people/Alex-Eames/100000616574757 Alex Eames

    Central Banking – a complex system for misinterpreting economic indicators in such a way as to promote the printing of fiat currency

  • Anonymous

    Shaun, thanks for explaining what is happening. I find your blog really helpful in making sense of what is going on.
    I am not an expert, but to a layman like me it sounds as if “round-tripping” by the ECB has much the same effect as QE by the Bank of England and the Fed.  That is, bankrupt governments get to carry on borrowing and nobody knows or cares (except you) about how the balance sheet will eventually work out.  Am I missing something?.

  • Drf

    Inflation: a way of servicing a new type of balloon in which the more counterfeit air that is pumped into it, the lower all costs and prices in an economy become (politically).

    Lewis Carrol (the Oxbridge Mathematics Don, who wrote the “Alice in …” series of children’s books) summed up all of the desired gambits for all political and economic terms and definitions in a statement of Tweedledum or Tweedledee (I forget which particular one of these characters it was); “A word means precisely what I want it to mean at any particular time, nothing more and nothing less” (or something near to that).

  • Vegetarian

    Acronym: EFSF – European Fiasco Stability Farce

  • http://kkalev4economy.wordpress.com/ Kostas Kalevras

    So as long as you have collateral (Spanish government bonds are collateral) you can have as much money/liquidity at an interest-rate of 1% as you want for three years.”

    Actually, the interest rate in the 3Y-LTRO is not fixed. According to ECB itself:

    “.The operations will be conducted as  fixed
    rate tender procedures with full allotment. The rate in these operations will
    be fixed at the average rate of the main refinancing operations over the life of
    the respective operation. Interest will be paid when the respective operation

  • Critic Al Rick

    Hi Shaun.

    A few suggestions for your Financial Dictionary:

    all: 99%
    fair: what’s best for the 1%
    inflation: robbery by stealth
    diplomacy – corruption by stealth
    flatlining economy: depression by stealth
    bureaucracy – platform for corruption
    CPI: 75% of median experienced inflation rate
    recession: real growth of less than minus 2%
    democracy – government by parasites for parasites
    money – a medium of exchange and for robbery by stealth
    pension fund – a quantity of hard earnt money amassed by some of the 99% in
                         anticipation of being less of a burden in their retirement to future
                         generations, but largely for the benefit of the 1% to squander now,
    tax – money to pay interest on government debt

  • Rods

    Hi Shaun, been great blogs all week.

    It sounds like the round trade is another lifeboat waiting to capsize as the more distressed an economy becomes, the higher the bond yield, so the banks can buy  more and make more money. Heads they win, and if it all goes wrong, tails the tax payer loses.

    Financial Dictionary:

    Bank stress test = Confidence trick
    Bankers apology = Not my fault gov
    Bankers conscience = Something that is more difficult to detect than a Higgs boson particle
    Bankers moral hazard = Its your tab
    BOE = Bank of Errors
    CDO = A game of pass the parcel
    Economic political statement = Try to make the unbelievable believable and fail
    Eurozone bailout plan = A game of can kicking, a fantasy or an increasingly short period of time
    Eurozone Convergence = DivergenceEFSF = Titanic or Dead Parrot
    High inflation = A small blip in time
    In a strong financial position = Won’t be bankrupt until at least next week
    MERKEL = Multiple Errors Relating to Knowledge on Economic Laws
    Merkozy = Spending time with your pet dog
    No bailout required = Bankrupt
    Political unity = Politicians agree to disagree
    Sarkozy = Name of Merkel’s pet poodle
    Shock and awe = Damp squib
    On top of the economic situation = Fervently praying that something will turn up
    Rating agency = An apology for being late
    Rating agency downgrade = Too little, too late

  • Anonymous


    Actually you are agreeing with the head of the European Central Bank Mario Draghi who called the new measures ( there was more than just the LTRO I described above)  nearer to QE than people thought….

    In terms of impact I am waiting to see the size of Tuesdays LRTO

  • Anonymous

    Thank you for the Lewis Carrol mention as that is a quality quote which is so relevant in these times.

  • Anonymous

    Hi Rods

    Thank you for the compliment and for the suggestions.

  • Anonymous

    Hi Kostas

    Thanks for the information and apologies for not  specifying between a fixed rate and a fixed average rate. You are correct to point this out. Sorry.

    This poses even more questions about future ECB policy although I notice (as ever) that for the banks there is a get out clause.

    “Additionally, after one year banks will have the option to repay outstanding amounts received in these operations, which gives them a high degree of flexibility, facilitating their liability management.”

    I feel that the quality of comments to this blog is a clear strength, so thank you to all who reply.

  • Drf

    Hi Shaun, actually I have noticed that I was not accurate in recalling this from extremely distant memory. The Lewis Carrol quotation I intended to mention was from `Alice Through the Looking Glass’, and the statement was in fact made by Humpty Dumpty.

    “When I use a word,” Humpty Dumpty said in rather a
    tone, “it means just what I choose it to mean – neither more nor

    “The question is,” said Alice, “whether you CAN make words mean
    so many different things.”

    “’The question is,” said Humpty Dumpty, “which is to be master–
    that’s all.”

  • Russell Branch

    Hi Shaun, I have another few definitions:

    Shaun-ists – those who read the Shaun Richards blog, and see the emperors new clothes for what they are :-)
    Permanent – the same as Temporary, but with less emphasis on time
    Fiscal Convergence – financial domination by Germany
    Technocratic government – temporary dictatorship (but see Permanent, above)

    thanks, as always, for the blog.


  • Anonymous

    ” Output gap theory” – a theory monetary policy-makers use to explain decreasing inflation in an inflationary surge

    “ You cannot prove the counterfactual” – an argument used by monetary policy-makers to prove the Output gap theory works

  • Justin

    A bit late of the mark, but how about including this one

    Hopium (noun): An injection of words and/or rumours announced by central planners to support financial markets without any concrete support.

    Jedi Economics (see also Ben Bernarke): The use of positive rumours and mind tricks to manipulate markets despite lack of action.


  • Anonymous

    Hi Justin

    Thank you in particular for the Jedi reference. I did see mention of an online Jedi conference over the weekend…..

    The FOMC Member whose name I need to check the spelling of each time I mention him Narayana Kocherlakota has been involved in Jedi mind trick mentions too.

  • Anonymous

    Thank you Shire and it is back in one or two places as an explanation for what is going to happen (in their opinion) in 2012. Sadly I have not been in a position to enquire as to how it explained 2010 and 2011……….

    For new readers the answer is that it did not and failed as a predictive system.

  • David Micheal Lilley

    I hope that we don’t look back in years to come and charge Super-Mario with reckless banking. After all the PIIGS are todays NINJAs.

    I too immediately understood why Spanish bonds were 2% less yesterday. Because 253 potential buyers could borrow at 1% and buy at a yield of 4% and these 253 knew yesterday what the rest of us have learnt today.

    The ECB has 350b Euro in the safe that has been deposited by EZ banks for safe keeping as they will not lends their spare cash to other banks.

  • Anonymous

    Hi David and welcome to my part of the blogosphere.

    As you can see from my article I feel that that what you say has been true over the past week or so. However there have been plenty around saying that it will not happen…….

  • http://www.mindfulmoney.co.uk/wp/shaun-richards/spain-is-already-in-recession-and-the-danger-for-2012-may-be-an-economic-depression/ Spain is already in recession and the danger for 2012 may be an economic depression | Mindful Money
  • jonnymonny

    You say:”So the 2016 bonds which were issued yesterday at a yield of 4.02%
    suddenly look attractive do they not. You can finance them for 1% for
    the first three years of their life and make just under 3% a year (there
    will be a “haircut” applied by the ECB).”

    How and why would the ECB apply a “haircut”

  • http://www.mindfulmoney.co.uk/wp/shaun-richards/is-italys-improvement-genuine-or-a-mirage-has-she-just-had-a-lost-decade-of-her-own/ Is Italy’s improvement genuine or a mirage? Has she just had a lost decade of her own? | Mindful Money