Monday, September 26, 2011

"Risk On!" As Mega Bailout Package for Europe Takes Shape

I woke up this morning around 4 AM EST, and was surprised to see futures doing nothing in the U.S. as a plan seems to be forming in Europe to copy the United States of Bailout plan for 2008.  A few hours later they are ripping higher.  While there is still a long road to get 17 countries to agree and pass something along these lines we have a European sort of TALF + TARP + FED taking shape.  Ironically this is essentially what Tim Geithner instructed Europe to do a week ago, before he was sent home with his tail between his legs.  But after a week of market turmoil, European ears are far more 'constructive' towards learning how Americans bail out bankers.

In summary what the master plan appears to be is keep Greece on life support with bailouts, until Europe reaches a point the ECB + ESFS (on steroids) can take over, and provide enough of a ring fence around Italy and Spain.  Then Greece can go through with an orderly default, and said ring fence would be so massive as to mock speculators.

Now just a week ago the ECB wanted to hand off all bailout responsibilities to the ESFS (think European TARP), but with the potential for an "unlimited" balance sheet, the ECB is the bazooka (in Hank Paulson's terms) waiting to be unleashed.  That's not in their charter, as the ECB used to be the 'hard money' central bank, but the world is quickly changing.  With Trichet set to leave later this year, and all sorts of Germans (hard money types) either being pushed away (Axel Weber) or resigning over how the ECB now acts, once Mario Draghi comes into power - we should be ready for the ECB to act much more like the Fed.  Much as it was (and is) in America it is much easier to have the central bank do the dirty work rather than a federal government.  But to that end the original ESFS (which was around 440 billon euro) will now be levered up - potentially to 2 trillion+ euro (with backstops and guarantees from the ESFS and ECB) and be the [potential] bailout fund for Italy and Spain.  The idea here is to make the backstop so big, that it won't need to be used.  Again, this is a mimic of the United States plan.  The only thing missing is a change in accounting rules so the banks can mark debt on their balance sheets to whatever they see fit, rather than to current market prices.

So while solving little other than creating a huge moral hazard, creating an epic kick the can moment, and pushing more private sector debt into two 'off balance sheet' accounts (ESFS + ECB), we as market speculators rejoice.  Because in "free market capitalism" we want the government out of our hair as long as the market is going in the right direction, but the minute prices go in the wrong direction we demand they deliver the taxpayers money to us.  Of course we are now dealing with 17 governments rather than Hank Paulson running to Congress with 2 sheets of paper demanding a trillion, so the process is going to be quite messy.

Here is an outline of the plan via UKTelegrap

  • German and French authorities have begun work on a three-pronged strategy behind the scenes amid escalating fears that the eurozone’s sovereign debt crisis is spiralling out of control.  Their aim is to build a “firebreak” around Greece, Portugal and Ireland to prevent the crisis spreading to Italy and Spain, countries considered “too big to bail”.
  • According to sources, progress has been made at the G20 meeting in Washington, where global leaders piled pressure on the eurozone to fix its problems before plunging the world back into recession. In a G20 communique issued on Friday, the world’s leading economies set themselves a six-week deadline to resolve the crisis – to unveil a solution by the G20 summit in Cannes on November 4.
  • First, Europe’s banks would have to be recapitalised with many tens of billions of euros to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. The recapitalisation plan would go much further than the €2.5bn (£2.2bn) required by regulators following the European bank stress tests in July and crucially would include the under-pressure French lenders.
  • Officials are confident that some banks could raise the funds privately, but if they are unable they would either be recapitalised by the state or by the European Financial Stability Facility (EFSF) – the eurozone’s €440bn bail-out scheme. 
  • The second leg of the plan is to bolster the EFSF. Economists have estimated it would need about Eu2 trillion of firepower to meet Italy and Spain’s financing needs in the event that the two countries were shut out of the markets. Officials are working on a way to leverage the EFSF through the European Central Bank to reach the target
  • The complex deal would see the EFSF provide a loss-bearing “equity” tranche of any bail-out fund and the ECB the rest in protected “debt”. If the EFSF bore the first 20pc of any loss, the fund’s warchest would effectively be bolstered to Eu2 trillion. If the EFSF bore the first 40pc of any loss, the fund would be able to deploy Eu1 trillion. 
  • Using leverage in this way would allow governments substantially to increase the resources available to the EFSF without having to go back to national parliaments for approval, which in a number of eurozone countries would prove highly problematic. 
  • As quid pro quo for an enhanced bail-out, the Germans are understood to be demanding a managed default by Greece but for the country to remain within the eurozone. Under the plan, private sector creditors would bear a loss of as much as 50pc – more than double the 21pc proposal currently on the table. A new bail-out programme would then be devised for Greece.
  • Officials would hope the plan would stem the panic in the markets and stop bond vigilantes targeting Italy and Spain, which European and IMF figures believe should not be in any immediate distress but are in need of longer-term structural reform.

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