State Pension Fund a Large Buyer of Government Bonds

We recently discussed with a friend who the big buyers of Spain's government bonds actually were in the wake of Draghi's 'OMT' promise. Surely that promise alone couldn't have led to such a buying frenzy, considering that the fundamental data haven't  improved – rather they have gotten worse. Our first guess was that the commercial banks were the biggest buyers, and they have indeed ramped their holdings of government bonds to a record high. After all, this is a very profitable carry trade for them. No capital needs to be held to cover the risk of sovereign bond holdings, and they can borrow from the ECB for peanuts and are still getting nearly 5% on the 10 year government bond,  and 3.6% on the 5 year bond. Even the 2.25% on 2 year notes appear a good deal with the refi rate at 75 basis points.



Spain, 10 year yield

Spain's 10 year government bond yield, via BigCharts – click for better resolution.


However, as data from the Bank of Spain revealed, although domestic bank holdings of Spanish sovereign debt are at a record high, purchases have slowed down from the frantic pace we have seen in the first half of 2012.

Now it turns out that the very state pension fund which the government has raided last year was also a very large buyer of its bonds – €20 billion of them, all told.




According to Bloomberg:



“Spain’s pension reserve-fund ramped up its holdings of domestic debt last year, profiting from a rally across southern Europe and making it easier for Prime Minister Mariano Rajoy to raid the fund to finance his budget.

The so-called Fondo de Reserva de la Seguridad Social in 2012 increased its domestic sovereign debt holdings to 97 percent of its assets from 90 percent at the end of 2011, according to its annual report due to be presented to lawmakers today at 12:30 p.m. in Madrid and obtained by Bloomberg News.

The fund purchased about 20 billion euros ($26 billion) of Spanish debt last year, while it sold 4.6 billion euros of French, Dutch and German bonds. More than 70 percent of the purchases took place in the second half of the year, after European Central Bank President Mario Draghi pledged to do “whatever it takes” to defend the euro, boosting Spanish bonds.

The European Commission has called on Rajoy to cut costs related to its aging population as the prime minister struggles to patch up a budget ravaged by a six-year slump. His People’s Party government is the first to have tapped the fund started in 2000 to provide Spain’s tax-funded pensions system with a safety net. It used the cash to partially compensate pensioners for inflation.

The bond-buying strategy enabled the fund to end 2012 with 63 billion euros, an amount equivalent to 6 percent of Spain’s gross domestic product. A 3 billion-euro gain offset part of the 7 billion euros used by Spain’s Cabinet starting from September to finance an increase in retirees’ pensions and Christmas bonuses, according to the report.

Spain’s state-run social security system, also in charge of unemployment benefits, stopped registering surpluses in 2011. Its deficit was 1 percent of GDP last year, contributing to the nation’s total budget gap of 10.2 percent of GDP.”


(emphasis added)

To recap: the state-owned pension fund buys the government's bonds, which then raids the fund to pay for its obligations. Nevertheless, the pension fund's deficit is not as large as it might have been because the central bank promised to also buy the government's bonds if needed, whereupon they soared in value. Brilliant…that's the philosopher's stone right there.

Or maybe not, as it appears that the game has not been perfected yet – there was still a deficit at the end. As an aside, the budget gap of 10.2% of GDP last year was so far off 'target' that it is no wonder that the ship came close to capsizing before Mr. Draghi waved his OMT promises around. There's a good chance that this year's numbers won't be any better. However, since some € 63 billion remain with the fund, it is surely good for a few more raids.




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