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ECB's Balance Sheet Contains Massive Risks - Fullermoney

Last updated: 04:16 26 May 2011 EDT, First published: 03:16 26 May 2011 EDT

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ECB's Balance Sheet Contains Massive Risks - Thanks to a subscriber for this informative article by Matthias Brendel and Christoph Pauly for Der Spiegel. Here is a section:

The ECB maintains a list of "eligible assets," a sort of seal of approval for securities. Every major bank in the euro zone must have such securities, such as bonds or government bonds, or it would be excluded from the money market. There are currently 28,708 securities on the ECB list, with a total value €14 trillion at the end of 2010.

The national central banks determine which securities are placed on the list and under what conditions. "The ECB has no obligation to supervise the central banks, nor does it have the ability to monitor individual central banks," explains an ECB spokesman.

In other words, ECB President Jean-Claude Trichet doesn't even know exactly what kinds of risks he is taking on. In principle, the conditions for ECB investment-grade securities are outlined in a 37-page document, most recently updated in February. To keep the risks for the central banks within reason, some of the haircuts on securities are very high, comprising up to 69.5 percent of the value of a security.

However, the degree to which individual central banks strictly adhere to these rules varies. This leads to irregularities that should simply not occur in a bank, let alone a central bank.

For example, Depfa Bank, the Irish subsidiary of the scandal-ridden German bank HRE, had 78 securities placed on the ECB's list of investment-grade securities in February. According to documents SPIEGEL has obtained, 25 of those securities appear not to have been sufficiently discounted.


My view -
There was a great deal of speculation about who owned various bank and sovereign bonds at the commencement of the credit crisis in Europe. Since 2008 and following massive continent-wide supports for banks, a large number of toxic loans have been posted as collateral at the ECB. This article from Bloomberg contains a number of quotes reiterating the European policy of playing for time to allow the banking sector to raise its capital ratios to an acceptable level. Here is a section:

"Chances of a non-triggering event are increasing," Peter Schaffrik, head of European fixed-income strategy at RBC Capital Markets in London, said in an e-mailed note. "This could lead to some selling pressure on the underlying bond markets," he wrote, though it's likely that "sizes in the CDS market are simply too small to cause a large stir in the underlying sovereigns markets."

This section continues in the Subscriber's Area.


Email of the day (1) - on when margin requirements are reduced:

"Gentlemen, this is an interesting map which may be of interest.

"I have a question...when margin requirements are increased, when are they reduced again, is it when price reverts to the mean or, when the number of contracts contract to a certain level, or what? I have not been in the markets long enough to have seen this happen before, so any experience you can share on the subject will be very helpful and much appreciated. Many thanks

"PS. I love chocolate and I have some almost every day, either 100% as a drink, or 85% in bar form and I try to buy the best quality that I can. I'm very fortunate because I can afford both chocolate and Fullermoney (the kids finished college 5 years ago), but, if I could afford only one, it's very simple, the chocolate would have to go. Readers of the free abbreviated Fullermoney Comment of the Day, I implore you to where possible, cut out your 'chocolate equivalent' take the plunge with a full subscription and if you pay attention, soon you will be able to buy more chocolate than you can eat."


My comment - Thank you for the attached map which I'm sure will be of interest to subscribers. I share your love of chocolate and we appreciate the sentiment but you should take full credit for seizing and profiting from opportunities in the market.

We are not familiar with the exact mechanism used by exchanges in determining margin requirements, particularly following an acceleration in prices. I found this pdf of Minimum Performance Bond Requirements on the CME's website which contains data pertaining to silver's margin requirement beginning in January 2009. It clearly demonstrates a hiking of margin requirements as prices advance and lowering of them once prices have declined.

It is not clear just how the decision is made to lower margin requirements once prices have topped out. This chart of silver's open interest over the last decade demonstrates more the closing of positions close to expiry rather than the impact of changes to the margin requirement. I suspect that large price advances which endanger the correction functioning of the market are the primary impetus of aggressive margin hikes. If this is the case then it would not make sense to rush to lower margin requirements until prices have pulled back emphatically. If subscribers have additional information on this topic I'm sure it would be of interest to the Collective.


Email of the day (2) - Tim Price's comments yesterday

"Tech. See below Aviate Secs re Facebook. 10x PER....no bubble here if true. There was no e-retailing model in 1999. Now there is, so (without irony) "it is different this time".

"We can sneer at 500x PER (and I simply don't like tech to invest in as barriers to entry so low and product cycles so fast), but there are in fact good and bad bubbles.

"Good bubbles make things change or somehow different in our lives, usually for the better. Good bubbles create new techs (railways in 19th C, healthcare in 20th C, internet in 21st C etc etc) by financing them. Bad bubbles only serve to pump up useless uneconomic asset prices (Toyko RE 1980s, tulips, Gold....yes, I really wrote that.....I can not think of one single generalized "use" for gold). Bad bubbles leave our lives basically unchanged. Bad bubbles can however change us psychologically, I would argue for about one generation, as investors "learn" that gold is a bad -or good- investment.

"1999+ tech bubble was a good bubble as it changed the way we live our lives. The e-retailing model is now proven (not so in 1999).

"I think we should use the word BUBBLE more discriminately in future, even though the investment result may be similar in both cases (nemesis / unsustainable crazy prices, catharsis /collapse etc)."

My comment - Thank you for this informative email. From a social perspective, yes there are many positive aspects to investment manias. Rail roads got built to open up the West, the TMT revolution introduced efficiencies which continue to change how we live and do business. However from an investment perspective, market manias are all the same. They all represent a time when expectations becomes divorced from reality.

This section continues in the Subscriber's Area.


Email of the day (3) - on when to buy India:

"Sell in May and go away" - but where to? I think I know where and would like to run it by you, as, I am sure, would other subscribers. India is the place. "Buy India at the end of May, sell again on Christmas Day (or thereabouts)."

"Using your 5 and 10 year charts over the last 8 years I have found that buying at the end of May or June 1st. and selling at year end yielded the following results:

"2003 82% gain
2004 41% gain
2005 40% gain
2006 35% gain
2007 39% gain
2008 27% loss
2009 19% gain
2010 21% gain

"The average annual gain excluding the disastrous 2008 has been 40%. If 2008 is included it is 31%. The global crash of 2008 affected this time slot in India much less than most of the world. The exact dates seem to be of importance.

"What do you think? Wonderful service. Look forward to meeting you again at the November TCS."

My comment - Thank you for sharing this insightful analysis. India has been a spectacular performer over the last decade and you are correct to point out it does best in the second half of the year. Your email is well timed since the Sensex is currently at an interesting juncture.

This section continues in the Subscriber's Area.


Email of the day (4) - on the PowerPoint for my "Greatest Urbanization in History" presentation:

"I attended your talk on the 'Greatest Urbanisation In History' in Singapore early this month. Could you forward the slides as I can't seem to find them on the website?"

My comment - Thank you for your support. Here is a link to the PowerPoint presentation and it is now also available in the Presentations section found in the menu to the upper left.


Email of the day (5) - on the recent London Chart Seminar:

"I would like to extend my appreciation to all the team behind the London Chart Seminar. From a future marketing perspective it would be beneficial for you to state who and why they attended. I was shocked at the quality of the delegates and the distances they had travelled. If there had been a tally of funds owned or under management in the room, it would have made your eyes water.

"I met David initially at a Dealers Group Seminar; I am an enlightened IFA, dis-believing much of what I have been taught over a twenty year period. This knowledge has been presented by a fund management industry hell bent on preserving the status quo.

"Could you add some funds to the library please? There is a fair buzz in the UK over Vanguards indexed offerings. They appear cheap and do what they say on the tin. I use the Vanguard FTSE UK Equity Index Fund as a good proxy for "dividend aristocrats". In a world where almost all advisers earn commission it is not hard to see why the fund has only 65m in it and we have about 7m of that. (They don't pay commission) The positive cash inflows are good for trackers currently as more advisers move from active to passive. It should help with rebalancing where not too much cost need be incurred in selling.

"Eoin, I tried not to be a performing seal waiting for a fish, but your rewarding of the crowd taught me how to present in future. No chance of people not participating when they are positively rewarded, even with a brolly! "

My comment - Thank you for your kind words and your valuable contribution to a number of debates at the recent London event. David introduced The Chart Seminar umbrella very early on and I am delighted to still be able to judiciously award such a long coveted item. The not so secret benefit of The Chart Seminar is the depth of experience delegates bring to bear during group discussions of markets.

Thanks also for pointing out the inherent conflict of interest in IFAs recommending funds from which they receive hefty commissions. The fee based business model you champion is a laudably ethical approach which we hope gains wider acceptance. I have added the Vanguard FTSE UK Equity Index Fund to the Chart Library.


Email of the day (6) - on an addition to the Chart Library:

"Please add NBL: LN to your chart library (Noble Inv, coin trading) Thanks"

My comment - Thank you for this suggestion which has been added to the Chart Library.


Email of the day (7) - on price differentials between the Chart Library and other services:

"I think there is an error in the chart for UCU - Ucore Rare Metals. As per Yahoo, the stock closed at 0.65 on 24 May, and the day's range was 0.63-0.68. Kind regards"

My comment - Thank you for raising this issue which crops up from time to time. The Chart Library displays prices adjusted for corporate actions, other services do not. UCU announced a private placement in December which probably helps to explain the divergence in prices.


The Chart Seminar 2011 -
The November dates for The Chart Seminar are filling steadily following a sell-out tour to Sydney & Singapore and a successful start to our London series last week.

Anyone interested in securing a place at any of our events should contact Sarah Barnes at sbarnes@fullermoney.com.

The full rate is £950 + VAT. The early booking rate of £875 for non-subscribers expires on September 30th. Paid-up Fullermoney subscribers are offered a discounted rate of £850. Anyone booking more than one place can also avail of the £850 rate for the second and subsequent delegates.

The date and venue for my remaining seminar in 2011 is:

London - November 3rd & 4th at the Radisson Edwardian Hampshire.


Please note -
David is currently on holiday and will return on June 6th. 

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