Sunday, October 30, 2011

Once the Euphoria wears off.....................

Some initial thoughts from last weeks European party:

  • 50% proposed haircut that the headlines were full of, actually closer to 16%. Why? Greek debt approximately EUR 350b. Of which approx. EUR 150b held by Greek and European central bank, which is not subject to any restructuring. Leaving us with about EUR 200b. Greek banks and pension funds own about EUR 85b. This is contentious and debatable, but if they take a 50% haircut, they will essentially be bust. Hence, they may well be absolved too. That leaves EUR 115b that will "voluntarily" take the haircut. 50% of which, is EUR 57.5b, or 16%.
  • The initial reaction was euphoria, with PIGS bonds falling drastically. But once the euphoria wore off, Spanish and Italian bonds made a quick u turn, and are back to the levels they were trading at pre-announcement, dangerously close to the 6% level where other countries have required help. Why? Because EFSF doesn’t take a default off the table. It delays the time until default, by rolling maturities, but all it really does is shift who takes the loss. And Italy and Spain are too big for ANYONE to take the loss.
  • The EFSF is leveraging EUR 440b 4 or 5 times, just 3 weeks after Merkel promised the Germans that it would not be leveraged. The leverage would use the EFSF AAA credit rating to enhance new debt and set up Special Purpose Investment vehicles to obtain the leverage. I.e. more of the problems of the 2007/08 credit crises.
  • How does the leverage work? EFSF is like an empty box filled with promises of money- many of them from the very people who are most likely to need to borrow that same money. So should they need to borrow the money. They won't be able to fulfill their promise, so there will be less money for them to borrow. And then they've decided to leverage these empty promises of nothing.
  • Who is going to buy into the new leveraged EFSF fund? Sarkozy seemed to imply if China WANTED to contribute, then Europe would probably be open to allowing them. However, Chinese Prime Minister said "Countries must put their own houses in order". A member of the Chinese central bank went on to say "It is in China's long term and intrinsic interest to help Europe because they are our biggest trading partner, but the chief concern is how to explain this decision to the Chinese people. The last thing China wants is to throw away the country's wealth and be seen as source of dumb money". China is extremely likely to invest in the EFSF, but on terms that are favorable to China.
  • This was no solution. It’s a plaster for a long term problem. Don’t forget that at the last stress test, Europe's strongest bank was Dexia ……
  • Also, the fact that these private investors were forced to take a voluntary haircut to the tune of 50%, does not create a credit event. I can't imagine the big banks who hold CDS's will take that lightly.
  • And further, who is going to want to buy sovereign bonds now? At least beforehand, I can buy protections in the form of CDS's. Now that CDS's have been deemed worthless, why should I buy these EFSF bonds? Who is going to buy these bonds? Someone has to, otherwise Europe will blow up. And best case scenario, is that there are buyers, but too few of them, hence an - oversupply, a low price, rising yields ...... problem sounds familiar?

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