In the financial markets a “PUT OPTION” is an agreement to sell an asset at a future date at a specific price.
So if an investor thinks an asset may fall they “SELL A PUT OPTION” which gives a future protected sale price on what they own.
Central bank put option
During the US Federal Reserve Presidency of Allan Greenspan the financial markets came to believe that the Federal Reserve stood ready to provide a floor to asset prices.
When markets declined the Fed would step in with accommodative monetary policies (usually lower interest rates) to stimulate the economy and thus help buoy up asset prices.
(Examples included Iraq war, Enron and Worldcom scandals and dot com bubble bursting.)
This became known as the:
When markets fall, Greenspan acted to underpin them with cheap money.
After President Greenspan, came President Bernanke who from 2008 was very clear that the Federal Reserve would do whatever was necessary to support the US economy whilst it worked through the housing crash and deleveraging, and towards higher growth and most importantly (certainly politically) a return to unemployment of around 6% (it’s currently between 8 – 9%).
So the “Greenspan Put” became the “Bernanke Put”.
Until the last month no such comparable situation existed in Europe.
The ECB (European Central Bank) has a far more opaque mandate and there are many dissenting voices (mostly Teutonic) which become elevated whenever the possibility of co-ordinated monetary actions are suggested.
The ECB is constrained constitutionally from directly assisting any single Sovereign nation, they are barred from targeting and relieving say Spanish or Italian debt structures, they may only act in ways which are communal.
Several weeks ago with European markets falling and with Spanish and Italian bond yields very elevated the ECB President Mario Draghi acted decisively.
He gave a speech in London (just prior to the Olympics) in which he said:
“The ECB will protect the integrity of the Euro, we will do “WHATEVER IT TAKES””.
That was the big bazooka.
“Whatever it takes”
The European markets had heard what they had been craving to hear, they had:
“The Draghi Put”
Since the speech, markets in Europe have risen, as an example Banca Santander whose share value before the 2008 crisis stood at 10 euros and at the beginning of August 2012 stood at 3 euros now sits at just below 5 euros and is rising daily.
Chancellor Merkel has given her support to President Draghi whilst the Bundesbank gives the impression of having a seizure everytime “unlimited bond buying” is mentioned. Maybe this is management of the German electorate or maybe this is for real but either way German politicians realise that Germany is amongst the most severely damaged if the situation spirals out of control, the Bundesbank has a mandate to control German inflation and unlimited bond buying (sterilised or not) by the ECB may well create inflation but the analogy is this.
There is an institution (Bundesbank) sworn to protect the right leg of a body, the institution charged with protecting the whole body (ECB) must overrule objections from individual body parts when the whole body is in mortal danger.
Even though the treatment deemed necessary for the whole body is unpleasant and unwelcome for the right leg, if the whole body dies, the right leg however virtuous in its own behaviour is equally as dead.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.