What Do $100 Billion Of Ponzi Bonds Mean?

So Italian banks have issued about $100 billion of these Ponzi bonds and even in this day, that is a big number.

Banks issue bonds to themselves. Then they get an Italian government guarantee. Then they take those bonds to the ECB and get money, which I assume they use to pay down other debt mostly.

The Italian banks and Italian sovereign debt markets are essentially becoming one and the same.  The sovereign has added 100 billion of risk to the banks (that today no one is focused on) and the banks and ECB would have to come up with some new gimmick if the sovereign had problems.

The circularity has been powerful during this rally, but it seems too clever by half. It is an all or none strategy, and the ultimate double down.  If it all works, then it is genius. If we see another round of weakness, we have the start of a death spiral.

These Ponzi bonds ensure that Italian sovereign and bank spreads become 100% correlated over time.  The fact that LTRO has daily variation margin adds to the death spiral. The fact that the ECB’s outright holdings will be made senior to other holders is also an issue.  I have lost track of what the EFSF or ESM are currently doing, or plan to do, but some money is being used up on the latest Greek bailouts, and the reluctance to pre-fund it, means that risk of the market rejecting EFSF or ESM bonds at times of crisis remains high.

Spanish bonds continue to struggle, and other than love of their food and culture it is hard to say anything positive about what is going on in Spain.  Keep watching this market – it is starting to separate from Italy and not in a good way.

With Ben and Mario continuing to pump money into the system, the fear of renewed crisis has dissipated. On the other hand, their policies, far from creating a “firewall” have done nothing but provide tinder and gasoline ready and waiting for the next fire.

Buy puts. While the current central bank plans may work and it is a scary market to short, vol has come down (the front end more than longer dated) and the risk of a spectacular sell-off is real. Looking for some deep out of the money options makes a lot of sense.

The reach for yield always tends to end quickly and ugly and all you need to do is look at the treasury market to see just how quickly t can reverse course. At least treasuries are moving lower for some of the right reasons – better economic data. A sell off for the wrong reasons in any credit market will be ugly with so many people long and complacent.