The Corzine Trade vs French Downgrade

Posted by on Dec 16, 2011 in Uncategorized | No Comments

Today it seemed that the market latched on to the idea of the Corzine trade as being the new bazooka.  Banks would borrow lots of money from the ECB to buy sovereigns. It certainly seemed to be the case this morning when 3-year and in PIIGS bonds rallied hard.

There are several flaws with this as a plan to save the euro.

Banks can already buy virtually unlimited amounts of Spitalian bonds. The repo market for these remains orderly so they could finance themselves without the ECB. Maybe the ECB terms are more favorable but the reality is banks could already buy as much sovereign debt as they wanted.  The issue is that they already have more than they want. As banks use ECB funds to buy more PIIGS bonds, private investors will be squeezed out. The banks will have concentrated risk that private investors may not be comfortable with.  As banks rely on the ECB to fund themselves and to put on disproportionately large positions who will lend to them?  Who will buy the shares? At first it may seem good, but they will be at the mercy of the ECB and the politicians. With Greece the politicians have already shown a willingness to try to dictate policy for banks. The on again off again rumor of a financial transaction tax will come back.

MF didn’t have unlimited central bank backing but it is a bit strange to believe that the trade that brought them down will be the salvation of Europe.

This unlimited lending will be inflationary and reduce pressure on countries to address their deficits. The risk of a solvency problem hasn’t been reduced it has just been shifted.  If this deal is so good for banks, why bother lending to corporations or individuals? I think that is a key issue. For all the QE efforts we have made little of the cheap money has been let loose on the economy by the banks.

A little buying by banks, 20 billion of ECB purchases and an IMF rumor or two might be enough to get the markets to pop for a bit. The bearish bets on the euro have hit an extreme, making it even easier in thin markets to prop it up for a bit.

Belgium got downgraded. Not much impact but a clear warning shot that bailouts have a cost. Belgium bails out Dexia. Belgium borrows money. Dexia borrows from the ECB to buy Belgium bonds. That is not a solution but it is what we have.

I’m surprised S&P did not follow through this week on any sovereign debt downgrades. They had the air cover with Moody’s and Fitch stating how disappointing the summit was, but S&P remained silent. Have they agreed to remain quiet until next year?  The market has NOT priced in a downgrade. The market action today made that clear. The question is the timing of an announcement. I would now bet that if it isn’t out early on Monday, they will hold off until next year. That makes it easier for the market to forget that it is out there and try to rally.

Why is France trying to get England downgraded?  Do they really think adding more uncertainty is going to help? I understand that they are miffed but trying to get more countries to lose their AAA only adds to uncertainty.