Tuesday, 9 December 2014

The Goldman touch

In my previous post, I cast doubt on the viability of Juncker's investment plan, pointing out that it involves no new money from either the EU or the EIB since it relies on a combination of non-sovereign guarantees and money diverted from other schemes, and questioning whether the private sector would be interested in investing in member state pet projects anyway. To put it bluntly, it appears to be a conjuring trick designed to give the impression that the European Commission is "doing something" about the appallingly low level of investment across the EU. I (somewhat impolitely) commented to a friend that this scheme looked like an attempt by Juncker to prove that he is not a total joke.

But in this extraordinary comment on my post, someone who identifies as "cig" exposes a dimension to Juncker's plan that I had missed:
There is an obvious trade here:

1. get bridge loan of say €100m
2. create SPV
3. have SPV buy €100m worth of senior tranche of EIB project
3. have SPV (alone or with mates) issue covered bond guaranteed on these (+ admin spread)
4. sell covered bond to ECB
5. goto 2 (you've just got your €100m back from the ECB)

No risk for the trader here, she just makes the admin spread and uses zero long term capital (once the 300B are exhausted she gives back the €100m to the bridge lender). In that scenario it makes sense that it's the EIB that decides what project gets done as after all it's the ECB's money we're spending. Technically there's no monetary financing that a normal electorate can notice.
And cig adds:
Now I'd like to know is whether this trade is the very point of the scheme and who understands that... Note that even if it's not, it may still work out that way anyway. 
When I saw this comment, suddenly everything became clear....Draghi's public support for Juncker's scheme in his Jackson Hole speech, followed by the ECB's surprise announcement in September that from November it would buy both ABS (as expected) AND covered bonds. The confidence of policymakers about the likelihood of private sector involvement in this scheme is indeed well-founded. The ECB is standing behind it - not directly, because as I pointed out in the post that would be monetary financing of governments, but indirectly in the name of "monetary policy". Never was falling inflation more opportune. The private sector's involvement in this scheme is completely risk-free, and whether the investment projects actually generate real returns is completely irrelevant.

If "cig" is right, then this scheme has two purposes: overtly, it is to increase investment across the EU - and covertly, it is to circumvent the treaties that prevent the ECB from financing sovereign investment. 

As far as I know, no commentator has spotted this - not even the redoubtable Bruegel. Though I think the Cypriot economist Alex Apostolides understood it. "Why is all this crap better than a treaty change?" he asked me on twitter. Indeed, avoiding treaty change is what it is all about.

No way did Juncker dream up a scheme of such Machiavellian brilliance. This is the Goldman touch. Super Mario is at work.

Related reading:

Draghi's debt trap


  1. A few people in the structured finance world have already thought about this. It does not have to be covered bonds - it can even be ABS now. And if the ECB start buying corporate bonds, then the senior tranche may be sold directly to the ECB. There are many variations of this that have been discussed recently including some OECD economists suggesting a Sovereign Bond CDO as a means of getting around some of the issues that the ECB may have in financing sovereigns. The irony of the Juncker plan is that the EU are using securitization tools to solve a financing problem while at the same time arguing that all securitisations are bad and need to be regulated out of existence.

  2. Increased investment will be a disaster for the EUs population.
    Increasing costs without increasing company tokens means famine for most and fancy toys. for the few.
    Let's hope it never gets off the ground.

  3. France is a classic case.
    Its physiocracy for the few.
    Spend 10 billion on the tours PPP high speed line ( to be used by the cosmopolitan elite)
    While local lines are cut. ( luchon line just closed and the little yellow train on brink of closure because 120 million tokens is lacking)
    The excuse is people are not using these rural and now exclusively tourist networks but of course that is because purchasing power has been extracted.
    A chicken and egg thingy.
    This gross imbalance between the urban and rural hinterland is a characteristic of social systems immediately before collapse.

  4. Spain- a even more extreme case.
    Nowhere near enough tokens in the economy to use existing capacity.
    Any further increase in costs / investment without purchasing power to use facilities will lead to greater society collapse.

    The EU is simply a industrial concentration camp experiment.

  5. This is not about "circumventing the treaties", but about maintaining central control over how the magic money gets spent across Europe. The EIB is deciding what gets done and what doesn't, effectively leading policy across the board. Does Spain invest in road or rail? EIB decides. Does a new hospital or school get built in Lisbon? EIB decides. What are Italy's R+D priorities? EIB decides - this is massive, micro-managed central planning.
    German fear of inflation may be the narrative, the real fear is debt mutualisation, that sovereign QE-financing would create. Basket case S.Europe would not invest, it would just roll back austerity, and Brussels leverage over these Governments would be seriously weakened. QE via EIB keeps the wise men in Brussels in control.
    Unfortunately the EIB is not the benevolent do-gooder at no cost it is held to be. Its "support" has left a trail of devastation across Iberia in particular where it has part-financed projects that turned out not to be viable and has tempted Gov and local authorities to put up their own cash and take on more debt for the sake of not missing out on EIB cash, rather than really analysing the merits of what they are investing in.

  6. Aren't their regulatory impediments to this trade? Let's say you're a bank and you create an SPV that securitizes the EIB project loans. Even if you could then sell this security to the ECB, wouldn't you still have to maintain some skin in the game by keeping a portion of the covered bond or ABS on your books - for which you would then have to set aside some regulatory capital? If that was the case, this trade would not be totally riskless for the trader, and the administrative fees would have to be large enough to cover the cost of capital. If I am not mistaken regulatory constraints are part of the problem the ECB is facing in terms of getting the securitization market back up and running in the euro area. Or do EIB projects not face this regulatory constraint?

    1. What sort of regulations do you have in mind? The SPV can be structured like say an ETF, where the manager has no skin in the game, they just package other financial products and handle custody, etc. The ECB can buy an entire ETF if it wants to. So it can buy the whole issuance of this programme directly or indirectly.

      In practice it will look more palatable if they don't buy 100% of everything outright, and it shouldn't be that hard to find a bit of private sector participation here and there to spice it up. Not all projects will be crap, and it's not that the private sector never buys crap anyway. Indeed if they play their hand well, they might end up being able to flog some actual risk to unsuspecting idiots during some temporary euphoric market phase.

    2. Well, this is my question. But I believe there are rules that compel the originators of a security to maintain an interest equal to some percentage of the the total securitization, and perhaps even rules that restrict the ability of some types of asset managers to invest in securities that do not meet this requirement. But again - this is my question, as I'm not sure it necessarily applies in this case. More broadly, I do have the impression that financial stability concerns have been cutting across monetary policy goals in the euro area for some time now.

      Anyway, I take your point that there should be a way to get private sector participation in thi scheme and they won't have to twist anybody's arm to do so.

  7. Weayl
    Technology used not to enable people but to facilitate concentration of power.
    As late as 1990 in Ireland peat used for home heating was 32% of total , now much less then 10%.
    A collapse of local supply chains can be seen.
    I could give a example of a town in Kerry surrounded by blanket bog that was used locally.
    Up until the early 90s this was a bustling place.
    Now it is a dead zone.
    Overpowered by a dark modernity which extracts purchasing power to a extreme degree causing a break down of all local supply structures.

    I have seen this happen in so many areas,
    The ariege 100 years ago
    Aragon 50 tears ago
    The west of Ireland 20 years ago......
    Its the centralizing vortice...,....that ignores and indeed seeks to wipe out all local exchange up to the point of using dubious green propaganda / laws so as to destroy local village redundancy...,.

  8. http://www.constructalia.com/photoalbum/main/album_997/picture_11643.jpg

    Birdseye view of complete project with sunk costs.
    Project complete but stopped because of a lack of local tokens

    Solution - stop stock and flow dynamics so as to create living space for more machines and the capitalists behind them...........

    Europe is a social creditors proving ground.