Mario’s magic air fund

December 3, 2012 | Capital markets, Euro, Eurozone, Global news, Innovations, Speculation, Vaporware

By:David A. Smith


I’m ready to save the Euro … maybe


If insanity entails seeing visions no one else can perceive, then genius entails making other people believe your visions – and by this definition, ECB President Mario Draghi is clearly a very clever fellow with a long memory, for he’s recently reached back a quarter-century into Michael Milken’s old bag of tricks and revived the (in)famous Drexel Burnham Lambert ‘air fund’ with his conjuring of the Outright Monetary Transactions (OMT) commitment, a bit of political vaporware that has calmed markets for more than five months, despite the fact that it does not exist and there are no plans to create it.


So you’ve figured it out, have you?


Moreover, now that everyone believes the OMT will exist, and governments like Spain’s are flagellating themselves to purge their sins of profligacy in hopes of being received into the bosom of Mr. Draghi’s financial church, Mr. Draghi is making clear that, perhaps, no matter how much virtue a nation achieves, it may never be enough to win entry into heaven.  As reported with delightful bone-dry U snark in Capital Economics ECB Watch (November 29, 2012):


Once more into the editorial breach, dear friends

With my St. George French cufflinks


Having boldly pledged to do whatever it takes to save the euro back in the summer [September 10, 2012 – Ed.], ECB President Mario Draghi has struck a noticeably more cautious tone over recent months.


Pass Mario Draghi: collect €200 million?


Mr. Draghi’s newly voiced caution makes eminent sense; in fact, his previous braggadocio seemed to me completely foolhardy:


As I’ve said many times, one does not solve a solvency problem with finance: government spending has to go down, and this amidst a severe contraction in the Greek and Spanish economies.  All these billions of Euros being thrown into the maw buy time, but then the time bought is wasted.


A failure of those talks could still lead to a Greek exit from the single currency, with huge consequences for the rest of the euro zone.


By moves like this, the ECB completely undermines national spending discipline in profligate countries. The ECB’s only recourse, after having bought all this Greek paper, would be to cut off further credit and expel Greece for the Euro, and this the ECB has stated it will never do. To me this is unbelievably dumb:


How dumb can you be and still ride in a limo?


Actually, it may have been much more clever than I thought at the time, because it may be that Mr. Draghi never meant it at all:


When asked to offer assurance to Spanish Prime Minister Mariano Rajoy that the bond purchases would actually reduce Spain’s borrowing costs, were Spain to trigger them by signing up to the conditions attached to an ESM programme, Mr. Draghi was decidedly non-committal. 


Indeed, he emphasized that signing up to a program was a “necessary, but not sufficient” condition for OMTs and that “there is not any automatic quid pro quo.”


In other words, Mr. Draghi told the capital markets that the ECB will print money needed to prop up any and every country which meets ECB stringency criteria – and he told the Spanish (and others) to take painful actions to meet the criteria.  Then, when the Spanish wanted assurances that if they fulfilled the conditions, the loan would be forthcoming, Mr. Draghi’s answer boils down to two words made famous by Ahnuld:


“I lied.”


And I immediately flashed to Michael Milken’s famous air fund, probably the best piece of financial vaporware ever invented:


Great stuff, wasn’t it?


Drexel adopted aggressive and unconventional tactics backing hostile acquisitions.  Traditionally, companies lined up bank loans to support bids.  Milken evolved the ‘highly confident’ letter, which stated that Drexel was ‘highly confident’ that it could obtain the necessary financing.  Originally nicknamed the Air Fund, the highly confident letter lacked legal status, relying [solely] on Milken and Drexel’s ability to underwrite and place bonds to raise the money.  Drexel’s reputation meant that the letter was as good as cash.


In the early 1980s, that passed for a good stui


The Air Fund was a brainstorming invention of Drexel’s, and its beauty was that, like El Mystico Towers, it was thoroughly solid as long as everyone believed in it. 


I, Ken Verybigliar, believe in it


In the same way, Mr. Draghi’s OMT claims were backed by … nothing, and yet they worked:


Mr. Draghi pointed to evidence that the mere expectation of OMTs had already had some beneficial financial and market effects, including a pick-up in investment inflows from overseas, a rise in corporate bond issuance and tentative signs of a stabilization of the imbalances in the TARGET2 payments system.


So, in fact, Mario’s magic air fund has already bought several countries three months’ free time, and compelled their governments to adopt painful measures, and all without limiting Mr. Draghi’s freedom of action in any way.  That is as bloody brilliant as Henry II:


I found out the way your mind works and the kind of man you are. I know your plans and expectations – you’ve burbled every bit of strategy you’ve got. I know exactly what you will do, and exactly what you won’t, and I’ve told you exactly nothing. To these aged eyes, boy, that’s what winning looks like.


That’s what winning looks like, boy


Having calmed the markets and forced the Spanish to blink, Mr. Draghi now lightly skips away:


At the same time, he also offered little encouragement over the likely effectiveness of the plan to conduct Outright Monetary Transactions (OMTs) first outlined in September.


While no doubt repeating the line that the ECB stands ready to implement OMTs when the necessary conditions have been met, the President seems unlikely to offer any more encouragement about their likely size and effectiveness. And it would be nothing short of a shock if he did not remind euro-zone governments yet again that, when it comes to addressing fundamental economic imbalances and their fiscal challenges, the ball is very much in their court.


Were I the Spanish government, I’d be irate, and I’m sure the Spanish are.  Yet they have no recourse, no practical use for their anger. 


No way, Jose


They’ve been politically winkled by Mr. Draghi, and he still holds all the aces – and all of them are unplayed, and still face down:


Mario’s still got ’em


The ECB has shown few signs of warming to the idea of full-scale quantitative easing – that is, unsterilized bond purchases – for macro-economic stimulus purposes.


We expect more of the same at the post-Governing Council meeting press conference on 6December. While stating again that the ECB stands ready to put its bond purchase plan into action, he will re-emphasize that it is up to euro-zone governments to address the debt crisis. And he is unlikely to offer much hope of further imminent policy support for the broader euro-zone economy.


There’s only one thing you have to do:

And that’s do everything I tell you to do, each time I tell you to do it


Overall, then, the message will be that the ECB is standing ready to use its latest weapon, but is

unwilling to make any promises over how effective it will be and reluctant to allow governments to relax their own efforts.


A banker, goes the old joke, is someone who will lend you money only when you don’t need it.  Mr. Draghi is acting like a quintessential banker.


That’s for me to know and you to find out