Thread by @retreeb_io

The debtor, the creditor and the central bank.

A contemporary (& sad) fable by the lighting @AniceLajnef [Thread]

On reading our friend Anice's Thread on Twitter, we had to echo it
📣 Enjoy your reading! 👇
#greedyfinance ☠️

Let's imagine a spendthrift individual who constantly borrows money subject to interest. The usurer assesses the individual's profile and decides to lend him €100 against a written and signed promise: "I undertake to repay €120 in 1 year whoever presents this paper to me.

"Why is the usurer asking for a premium of €20? Because he knows that the individual is a big spender and has a lot of debt, so there is a high risk that he won't pay it back.

Let's say he estimated at 15% the probability of never getting his money back on this type of profile.

As the loan shark lends to many people with this risk profile, on average, out of the €120, he will recover €120 * 85% = €102. So, if he repeats the operation a lot of times, he will earn €2 each time he lends €100 on this type of profile.

If the assessment of the borrower's risk profile made by the loan shark proves to be fair, initially, when the paper is signed and the money is lent, the piece of paper is worth in theory €102 (and not €120 which remains the best-case scenario).

One day, the spendthrift's father, who turns out to be a billionaire, starts buying all the many promises to repay signed by his spendthrift son from the loan sharks he has had to deal with.

He buys the first promises to repay at €102, allowing the loan sharks to pocket the €2 of earnings (plus the €100 loaned) directly without having to wait a year. An unexpected windfall for the loan sharks!

Let us understand that the usurer when he separates from the paper signed by the borrower for €102, he has recovered his initial stake, plus €2 gain. So, he is out of the woods. It is to his billionaire father that the son must now repay the €120 at the end of the loan.

The billionaire doesn't stop here. He continues to buy all the promises signed by his spendthrift son: he buys at €104, then €106, driving up the price to €120! The loan sharks can't believe it, gaining more and more money.

In addition, loan sharks no longer have any risk facing this spender. The risk was transferred to the billionaire father in exchange for capital gains realized even before the end of the contract. What an added value! Up to €20! Much more than the €2 initially expected!

Strangely, when the billionaire buys the promises at €120 signed by his son, he estimates that his son will repay him with a 100% probability. So, he spends €120 getting €120 back. Hence the implicit interest rate is 0%!

All this concerns old loans. But when the spendthrift son goes back to the loan sharks, much to his surprise, they all fight to lend him €100 against €101, because they know they can sell the promises to the billionaire father in the next few days!

The spendthrift son does not hesitate and starts to borrow cheerfully. As expected, the billionaire father starts buying the new promises signed by his son from the loan sharks at €101. Easy money for loan sharks!

Their risky business at the beginning became a simple child's play. Loan sharks do not earn interest after a while, just as they used to, but rather quick profits after a few days, which are similar to commissions!

Especially since the dream does not end there for the loan sharks. The billionaire father even starts buying €102 repayment promises of €101 signed by his son. How crazy! He starts paying more to the loan sharks than his son is supposed to pay him back in a year!

Logic with probabilities mentioned above do not work anymore! By doing so, the billionaire father believes that his son will pay him back in a more than safe way! Implicitly, he buys his son's debt with negative rates! Never seen before!

As you can understand, the purpose of this story is to popularize one of the monetary policy angles of the #ECB when it buys the debt securities of states and multinationals (including #LVMH) in the secondary debt market.

The more the #ECB buys state and multinational debt securities, the more their prices rise, until they imply zero or even negative rates!

Banks and some investors have in a first phase been partially relieved of the risks they have taken against states and multinationals (from 2015 to 2019). Since the health crisis, banks no longer take risks, becoming mere intermediaries.

Banks are lending to states and multinationals knowing that the #ECB is going to go into the secondary market (like the billionaire father with the loan sharks). They generate commissions and price differentials on debt securities as well.

Thus, we understand that if rates are low this is not because states or multinationals are safer, but because the #ECB is in some way their beneficent guarantor.

The question, therefore, is how long the #ECB will be able to create money ad infinitum and inject it into the financial markets without completely destabilizing the trust we have in the currency!
End.
@salomesaque @MaximCombes