Europe Economy

Is Greece Using a Ponzi Scheme to Remain Solvent?

Matt Clinch, special to

Greek and other heavily-indebted euro zone countries' banks are staying afloat thanks to a system which creates a circular flow of cash not unlike a Ponzi scheme, analysts told CNBC on Wednesday.

Greece sold

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4.063 billion euros ($5 billion) of 13-week treasury bills yesterday with a uniform yield of 4.43 percent. It’s hoped this will enable it to repay the bonds held by the European Central Bankwhich mature on August 20.

This was the country's biggest auction in two years but it was mainly Greece’s domestic banks that bought the bills. The same domestic banks that receive Emergency Liquidity Assistance from the Bank of Greece. And that ELA is being funded by the European Central Bank through the Bank of Greece. The domestic banks are expected to use the short term bills as collateral to receive more ELA loans.

Nick Beecroft, Chairman at Saxo Capital Markets UK is worried by this strategy and doesn’t single out Greece and sees this happening in other peripheral countries.

“One has to be concerned that this is actually a huge Ponzi scheme,” he told CNBC. A Ponzi scheme being a swindle where later investors are used to pay earlier investors, giving the appearance of an opportunity where investments dramatically increase in a short amount of time.

“The LTRO ( Long Term Refinancing Operation , a cheap loan scheme from the ECB to give European banks more liquidity) accepts peripheral government bond as collateral, lends to the banks and the banks buy more of the peripheral debt. It is very circular isn’t it?”

This suggests that Greece’s domestic banks are effectively using ECB money to buy Greek bonds so they can continue to borrow from the ECB. Meanwhile the Greek government is selling bonds to its ECB-funded banks so it can repay the ECB for what it has previously borrowed.

The bailout deal (agreed in February 2012 by euro zone finance ministers) is in place to help the country avoid a default and ensure Greek banks can continue to borrow, which is currently helping them to survive.

So is this a last resort, a much needed way of keeping the Greek banks solvent, or could this circular flow of money be looked at as scam that investors should steer well clear of?

Bridget Gandy, Managing Director of Financial Institutions at Fitch Rating was in agreement that the circular money flow was happening.

“There’s some of that going on,” she told CNBC, discussing Spain in particular.

“The interesting thing in that is they’re borrowing at 1 percent on the LTRO, for example, and they’re getting 6-7 percent on a Spanish government issue. So that then gives them a profit to unwind the bad assets that they have got.”

Gandy suggested that relying on ECB funding is not good for any rating and this was only happening as the ECB have their hands tied.

“I think the ECB and the policy makers are pretty aware of that and are trying to limit how much of that goes on, but until they sort out the general problems with the Spanish banks, it’s going to be difficult for them to do anything else,” she said.

Greece sold

Mark Grant, Managing Director at Southwest Securities was adamant that these bond auctions in the euro zone periphery were just cash flowing in circular motions to keep banks solvent.

“It’s a circle that the ECB has created, where they fund, for instance in Greece, the Greek banks and then the Greek banks turn around and buy the bills. Then they pledge the bills back to the ECB to get cash,” he told CNBC’s “Squawk on the Street”.
“So in a sense it’s a kind of Ponzi scheme to be honest with you, that’s put forward by the European Central Bank.”

Grant is well aware that American investors fear Europe and that it wouldn’t offer the best opportunities with this circular flow of money.

“The real money guys, not the hedge fund guys, are either out of Europe or getting out of Europe,” he said.

Grant gave a stark warning that the debt piling up could have a very detrimental effect in the long term.

“The amount of debt that Europe is building is going to at some point or another cause a moment, like a Lehman moment ,” he said.

“When it comes, when it occurs and what sets it off I don’t know, but there’s way too much debt and not enough assets to guarantee them.”