Carry on Brussels

Find below a useful assessment of today’s European agreement by Russell Jones of Westpac.

Strategic Insights_Carry on Brussels


  1. Can someone please explain how the EFSF will be leveraged up?

    Am I right in thinking the EFSF will borrow money to buy the sovereign debt of troubled EU countries and recapitalise troubled banks?

    In other words, the EFSF borrows money to shore up insolvent banks that have lent too much money, and to buy debt from bankrupt governments that have been spending more than they earn.

    I just want to be clear on this, because it sounds completely and utterly insane.

  2. Oh no, it’s not that sane. The EFSF will become an SPV monoline insurer of a first loss tranche for private sector investors who buy the sovereign debt (or at least I think that’s it…)

    It’s not from Mars or Venus, it’s from Pluto (at least in terms of market clarity and deleveraging).

    • The EFSF will become an SPV monoline insurer of a first loss tranche for private sector investors who buy the sovereign debt

      Did you just make that up or does it actually mean something?

      • Well…precisely. It’s absurd but there you have it.

        It means the EFSF is an off-balance sheet special purpose vehicle (SPV) of eurozone governments that insures private investors against a portion of losses on qualifying sovereign bonds that they buy.

        As DE says it gets more perverse when you understand that the EFSF itself is only a bunch of promises from the core governments.

        In other words, it’s a CDO, a promise to pay something that promises to pay something if something else goes wrong.

        What could possibly go wrong?

  3. You can find more here

    Specifically you should note:

    “In order to reach its objective the EFSF can, with the support of the German Debt Management Office (DMO), issue bonds or other debt instruments on the market to raise the funds needed to provide loans to countries in financial difficulties. Issues would be backed by guarantees given by the 16 euro area Member States (see table below) of up to € 440 billion on a pro rata basis, in accordance with their share in the paid-up capital of the European Central Bank (ECB).”

    That is.. The EFSF doesn’t acutally have money, it has the ability to issue bonds backed by AAA rated sovereigns which under a “leverage” environment will be used as first loss insurance.

    Such financial beauty !!

    • DE, the 440 B Euro’s for the 16 member states that agreed to the EFSF so that would be central bank bonds. I wonder if the bonds themselves are leveraged? I don’t know what the basis of that capital is, but it would be interesting to know.

      • The statements said this:

        19. We agree on two basic options to leverage the resources of the EFSF:

        • providing credit enhancement to new debt issued by Member States, thus reducing the
        funding cost. Purchasing this risk insurance would be offered to private investors as an
        option when buying bonds in the primary market;

        • maximising the funding arrangements of the EFSF with a combination of resources from
        private and public financial institutions and investors, which can be arranged through
        Special Purpose Vehicles. This will enlarge the amount of resources available to extend
        loans, for bank recapitalization and for buying bonds in the primary and secondary

        But I don’t know the technical basis of it.

  4. So the EFSF is created and all will be well. Why has it taken this long if this is going to fix everything? Despite all the technical terms is this not just supposedly AAA countries lending more money to countries and banks that have all the hallmarks of inability to repay? Who ends up carrying the can if this doesn’t work? I don’t quite see who is going to make the 100% repayments and if they don’t what happens. I’m lost with this financial jiggery pockery! Is this safe to do at home?

  5. StanGoodvibesMEMBER

    and the SPIV seems to be dead in the water already because the BRICs have basically said they want no bar of it. China is still considering investing, but they will exact a heavy toll in favourable trade terms with Europe as part of the trade deal.

  6. Sentiment is a fragile commodity and this is at display now (the last months being no different imo)

    SO if EFSF insures or guarantees liabilities of weaker members it sounds a lot more similar to MBS as H&H astutely pointed out. A63 aluded to 2 options identifies in the document. What amazes me what shall bestow the confidence into private investors when the ink in which this document is written qualifies 50% discount (however dressed up in increased maturities or otherwise) as not being a default. So what is this risk insurance is exactly going to be worth to private investors? Does the official hil-billy confidence trickle all the way to final numbers or is it just a backstop measure with its definition subject to change at will of stronger members.

    As for second option will stronger members impose self-inflicting damage onto themselves if IIGS in the PIIGS follow suite. See, this is another example of the vicious loop Prince often talks about i.e. the higher the demand gets for the backstop, the weaker the backstop becomes. Also signalling limits as to leverage will not help (it only helps to extent that only G in the PIIGS or maybe another member becomes a victim…)

    DO these jokers realize that they are putting in place a structure that started the Great recession in the first place i.e. credit enhancements and leveraging. This euro version of ‘bazooka’ is severely rusted. It is not an unfettered commitment of a sovereign like US, instead a web of promises contingent upon peer members fronting their share of losses first, when the losses need to be booked.

  7. I suppose at the end of the day the ECB can find a way to TARP-olate the EFSF if need be! That would make Italian bonds almost as good as US Treasuries.