Once upon a time, treasury auctions were boring affairs. The Spanish treasury, for instance, would announce they needed to borrow a billion euros and the banks would place bids for their own account and either hold the bonds to maturity or resell them to their clients. The clearing price and interest rate at the auction were buried on page 23 of some obscure publication.
Naturally, that has all changed with the advent of the credit crisis. Now, everyone watches the auctions in order to gauge whether or not the market is willing to finance the Spanish treasury and at what rate. Also, being of the utmost interest, the clearing rate and size of each auction are now prominently displayed in all financial journals.
The question at this point is, who has the risk appetite to buy Spanish (or Italian) bonds and why? Do they have a different view of the Spanish economy that allows them to accept a 5% annual return at a time when some think Spain may be in default in a few years?
The answer seems to be neither. What seems to be happening instead (click here for a link in Spanish)
is that the Spanish banks have discovered a new way to make free money. They basically get loans from the ECB at 1% which they use to buy Spanish debt yielding 5%, thus, earning the difference.
So the next time you read that Spain (or Italy, or Portugal) raised money at an auction and that the demand was better than expected, or that the ECB is not buying government bonds, remember that money is fungible. The ECB is designed to lend to the banks who need it. Whether the banks decide to reduce or add exposure in the process is their problem and no Spanish regulator will ever chastise a bank for buying Spanish debt, no matter the scenario.
Charles Ponzi would be proud.
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