Thursday, 6 September 2012

The Sadist Markets Program (SMP) is dead. Long live the new Outright Masochist Program (OMT)

Let’s clear one thing. An “almost unanimous decision” does not exist. The decision was not unanimous . All bets are placed on Germany  on who is the dissenting vote.

Main Points:

· No yield cap on purchases. This is a good decision as mentioned in our previous note on reasons of anchoring.

· No limit on the size of purchases. This is also a good decision for the same reason as the yield cap.

· The new program Outright Monetary Transactions would replace the SMP. The SMP would be discontinued but its seniority status would persist.

· The OMT is going to apply after the countries sign up to and adhere to strict conditionality. (Greece for example did sign up but compliance was poor).

· The ECB would love to have the IMF involved. This is some change of heart with the original program on Greece, were the ECB opposed it. Obviously, they saw what a good job it has done and needs to be repeated.

· The OMT would respect the Pari Passu clause on the bond documents. Here I should mention that the Pari Passu clause and its interpretation is hotly debated on what exactly it means. In any case, it is interesting because it also means that they did not respect it in the SMP case. Furthermore they call it “Creditor Treatment”. Let us be absolutely clear on this. The ECB is NOT allowed to be a Creditor to any country. It is an investor and NOT a creditor. Hence their claiming on the SMP is “Preferred Investor” not Creditor.  To say that as investors would respect the bond contract is cheeky.

· On Collateral. There is going to be no rating threshold on any country that would participate in the OMT.

· The OMT program would stop if the conditionality is not met or if the country gets a clean bill of financial health. This begs the question on the so-called Backstop. What kind of a backstop stops functioning if a country does not respect the conditionality and is about to blow up? If a country does not manage to stick to the harsh conditionality (like Greece) then would the ECB stop the purchases and throw them to the abyss, thus risking the Euro?

· By the way, there is one line on Greece which basically says that Greek collateral is still not accepted by the ECB and thus Greece would continue to fund through the ELA. So the so called charm offensive of the Greek PM Mr Samaras was not very effective. Greece still needs a good Troika report to make any progress.

· The OMT can be activated once the EFSF/ESM starts buying in the Primary market bonds. So if a country signals its intention of accessing the market and the EFSF says that is going to buy some in the Primary markets then the ECB would also feel free to buy everything from the secondary market. Are we missing something here?

· The purchases would be sterilized. That should be no problem. After moving the deposit rate down to zero the plenty of excess liquidity would find the sterilization of even 1bp better than zero.

· The ECB would buy bonds with maturity of up to 3y. This is perfect for the 3Y LTRO. Banks in the Euro area can now buy the bonds from their governments and repo them to maturity with the ECB. This is exactly what MF global did and went bankrupt.


· What is the definition of a Monetary transmission channel or mechanism? And why is it in need of repairing? According to the statement, European inflation is well contained at around 2.4% (“To sum up, the economic analysis indicates that price developments should remain in line with price stability over the medium term. A cross-check with the signals from the monetary analysis confirms this picture”). If the transmission mechanism was in need of repair it does not show on this number which is the Primary mandate of the ECB.

· Draghi mentioned article 18 of the ECB statute that allows buying and selling securities outright. This is true, but the statute treats explicitly Public entities and governments under Article 21. And Article 21 forbids the ECB from being a creditor. If the treaty allowed the outright purchases of bonds why have separate provisions for Governments and Public entities?

· Would the “fully effective backstop” stop as soon as the country’s conditionality is not respected? Is this not an ineffective or defective backstop?

· If Ireland for example accesses the markets and the ECB buys some of the new Irish bonds then have we created two separate classes of the same investor? ECB’s OMT are pari passu and restructure-able while the Irish bonds in the SMP are un-restructure-able? I am bit puzzled.

· Would the ECB allow zillions of up to 3y bonds to be issued by governments only to be purchased by the local banks with the sole aim to repo them to maturity with the ECB? Is this not monetary financing? Any compliance department accountable to the FSA would call this layering a transaction. Because the ECB cannot, it uses a third party as smoke and mirrors.


Rejoice on the new program but we need to see the so called strict conditionality. This would come from the Council and the Commission. The EFSF does not set the rules of the purchases. On a lighter note, the Sadist Market Program has evolved to Outright Masochistic Program.