Don’t overrate the good news

In Spain, the carry trade seems to be operating (FT):

However, the success of recent Spanish government bond auctions has raised eyebrows. Spain sold €5.64bn of three-month debt on Tuesday, with the yield paid to investors falling to 1.735 per cent, down from the 5.11 per cent seen in a similar auction last month. Brokers say smaller Spanish banks may be loading up on bills to use as collateral at the ECB operations.

But don’t be too happy, here is from Jed Graham:

Much discussion — and possibly today’s stock market rally — has centered on the notion that the European Central Bank’s new policy of providing ultralow-interest, 3-year financing to banks can serve as a backdoor bailout of over-indebted sovereigns.

But don’t get too excited. This bazooka is actually a bulldozer. Rather than having the potential to flatten sovereign debt problems, it can only make them pile up into an untenable mountain — with far too much maturing within the 3-year life of the ECB program.

…Note that today’s [yesterday’s] Spanish debt sale comprised 3-month and 6-month bills.

As Reuters pointed out, Spain, unlike Italy, has relatively little debt to roll over before April. Thus, the 3-month and likely even the 6-month bills carry little risk.

But as Spain issues more short-term debt to meet new borrowing needs and to roll over maturing debt, the ECB’s backyard bulldozer is bound to produce a growing mountain of short-term funding needs.

Perhaps if Spain’s oversubscribed sale on Tuesday were for 5- or 10-year debt, one might make a case that the ECB policy was a real game-changer. But banks are unlikely to risk damaging their own credibility with investors by loading up on longer-term issuance of at-risk sovereigns.

Here is more.  The optimal policy here of course is time inconsistent. Lend out all the money and somehow forget to ask for it back, but don’t make that clear up front.  On a related note, another possible approach to the eurozone crisis is to have the United States guarantee all (non-Greek) eurozone debt, but if those countries can’t pay up simply void the guarantee, claim Berlusconi or someone blackmailed the U.S. government, and reaffirm the commitment to U.S. Treasury securities.  The market might just believe us.


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