The Fatal Flaw In Europe's Second "Bazooka" Bailout: 82 Million Soon To Be Very Angry Germans, Or How Euro Bailout #2 Could Cost Up To 56% Of German GDP

Tyler Durden's picture

A funny thing happened in Euro spreads today. While the bonds of all PIIGS countries surged higher in price (and plunged in yield) upon the announcement of the second Big Bang bailout, the reaction in core Eurozone credit was hardly as exuberant, and in fact spreads of the two core European countries pushed wider by the end of the day, and over the last week. Why? After all the elimination of peripheral risk should have been seen as favorable for everyone involved, most certainly for those who had been seen as supporting the ever more rickety house of European cards. Well, no. Basically what happened today was a two part deal: the i) funding of future debt for countries that are currently locked out of the market (all the PIIGS and possibly core countries soon) or in other words the "liquidity mechanism" which is being satisfied by the EFSF "TARP-like" expansion, and ii) the roll-over mechanism for existing holders of debt which "allows" them to "voluntarily" transfer existing obligations into a "fresh start" Greece which can then emerge promptly from the Selective Default state that is coming from Moody's and S&P any second, and supposedly allow the country to access markets as a non-bankrupt country.

For all intents and purposes the second can be ignored, because as has been made clear over the past few days, and as will be demonstrated below, the actual rollover from non-Peripheral banks will be de minimis, the bulk of impaired debt being held by banks in the host countries as is, and used as collateral with the ECB in the form of par instruments for cash.

Now the second part of the mechanism was never an issue further demonstrated by the plunge in net notional in Greek CDS as core banks no longer needed to hedge exposure and instead opted to divest their holdings. This is merely a red herring that attempts to confuse the issues associated with the first, and far more important concept: the nuances of the EFSF and its imminent expansion. And expand it will have to, because in reality what is happening is that the net debt of the countries will end up growing even more over time for one simple reason: this is not a restructuring of existing debt from the perspective of the host country! Simply said Greek debt will continue growing as a percentage of its GDP, meaning it, and Ireland, and Portugal, and soon thereafter Italy and Spain will be forced to borrow exclusively from the EFSF. Therein lies the rub. In a just released report by Bernstein, which has actually done the math on the required contributions to the EFSF by the core countries, the bottom line is that for an enlarged EFSF (which is what its blank check expansion today provided) to be effective, it will need to cover Italy and Belgium. As AB says, "its firepower would have to rise to €1.45trn backed by a total of €1.7trn guarantees." And here is where the whole premise breaks down, if not from a financial standpoint, then certainly from a political one: "As the guarantees of the periphery including Italy are worthless, the Guarantee Germany would have to provide rises to €790bn or 32% of GDP." That's right: by not monetizing European debt on its books, the ECB has effectively left Germany holding the bag to the entire European bailout via the blank check SPV. The cost if things go wrong: a third of the country economic output, and the worst case scenario: a depression the likes of which Germany has not seen since the 1920-30s. Oh, and if France gets downgraded, Germany's pro rata share of funding the EFSF jumps to a mindboggling €1.385 trillion, or 56% of German GDP!

The Europarliament, ECB and IMF may have won their Pyrrhic victory today... But what happens tomorrow when every German (in a population of 82 very efficient million) wakes up to newspaper headlines screaming that their country is now on the hook to 32% of its GDP in order to keep insolvent Greece, with its 50-some year old retirement age, not to mention Ireland, Portugal, and soon Italy and Spain, as part of the Eurozone? What happens when these same 82 million realize that they are on the hook to sacrificing hundreds of years of welfare state entitlements (recall that Otto von Bismark was the original welfare state progentior) just so a few peripheral national can continue to lie about their deficits (the 6 month Greek deficit already is missing Its full year benchmark target by about 20%) and enjoy generous socialist benefits up to an including guaranteed pensions? What happens when an already mortally wounded in the polls Angela Merkel finds herself in the next general election and experiences an epic electoral loss? We will find out very, very shortly.

Here is Bernstein with the full breakdown:

Continuation of the current strategy with a materially enlarged EFSF and private sector participation in liquidity support

Despite the failure of the current strategy, there is still a theoretical option of an extension of the current liquidity support with a materially enlarged EFSF that would also be buying government bonds in the secondary market. We believe this is the least likely option given the size of the fund required to achieve the objective.

An extension of the EFSF to cover Italy and Spain would require a €790bn (32% of GDP) guarantee from Germany

This strategy is not only unlikely to succeed but would also run into some serious structural difficulties. To cover 100% of the roll-over for Greece, Portugal, Ireland, Spain, Italy and Belgium as well as an allowance for bank support at 7% of the banks' balance sheets until the end of 2013, the support mechanism(s), would need to be able to deploy a total of €2.4trn in available funds.

Assuming the Greek Loan facility and the EFSM remain in place, the EFSF would have to increase its deployable funds from currently about ~€270bn to €1,450bn.

Given the 20% overcollateralization requirement on the current EFSF structure and the fact that countries that receive EFSF support are not able to provide valid guarantees mean that in order to create a €1.45trn funding capacity, the total fund would have to be €1.7trn. The guarantees to be provided by Germany would have to be €791bn or 32% of GDP.

There is a legitimate question whether in particular Germany would see the point of committing that kind of support to a concept that has so far been extremely unsuccessful. It also would expose Germany to a worst case scenario of a French downgrade. Without France, the guarantee need would rapidly move towards the whole of the €1.7trn. As the market is getting increasingly concerned about France, the odds are heavily stacked against an extension of the EFSF as a pure liquidity support mechanism.

If Banks were to participate in a liquidity expansion their contribution would be minimal

Within the current strategy one of the open questions is whether or not the private sector can participate by providing liquidity to the periphery countries. We believe this to be a fundamentally marginal discussion despite its enormous political importance.

Based on the stress test data released on Friday, we find that whilst the banks account for the majority of the very short term paper, their total share of the funding requirement into 2013 is just 23% and 16% of the total EFSF.

The question is how big the private sector participation could be. Taking the "French proposal" as a guide, the private sector participation would reduce the size of the EFSF by €137bn or 9% of the €1.45bn EFSF funding, assuming 70% of the debt is rolled over, 30% collateralization and 75% of banks participate.

The problem with this private sector participation so far has been the risk that this may be regarded as a default by the rating agencies. As a consequence the banks would have to write down these exposures to market prices. This exercise would lead to reported write-downs for the European banking sector of €75bn, 0.55 times more than the liquidity support that the EU is seeking. And in particular in Portugal and Greece the fallout of the MTM losses far outstrips the increase in liquidity.

Even more importantly, more than half of these losses would occur in the banks of the periphery countries themselves. In the absence of an open market for these banks, the losses would have to be made up by the governments themselves and subsequently added back to the EFSF utilization.


And there you have it: the cost of the euro not plunging today as a result of the ECB not proceeding with outright monetization, is that Germany is now the ultimate backstopper of all of Europe's risk. And while before, when the EFSF was just over €400 billion or so, the market could largely ignore the risk, a €1.5 trillion "upgrade" certainly changes the equilibria dynamics. In an attempt to avoid the appearance of inviting inflationary pressures on Trichet's central bank, Germany has directly onboarded the risk associated with terminal failure of this latest and riskiest "bailout" plan and in doing so may have jeopardized anywhere between 32% and 56% of its entire annual economic output. One wonders if the risk of runaway inflation is worth offsetting the risk of a plunge into the worst depression in the nation's history? It sure isn't for the Fed.

The most ironic outcome would be if the eurozone, in an attempt to prevent further contagion at the periphery, simply invited the vigilantes to bypass Italy (recall how everyone was shocked that instead of attacking Spain, it was Italian spreads that got destroyed in a manner of days), and head straight for the country on whose shoulders lies the fate of the entire EUR experiment?

Is Atlas about to shrug and topple the entire oh so heavy house of cards?



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Cheesy Bastard's picture

History shows that angry Germans are no threat to anyone.

Robslob's picture

6+ million souls may disagree

Gold Man-Sacks's picture

It's called satire, you literary genius, you.

Ahmeexnal's picture

Maybe it's Germany's way to pay compensation to Greece for WWII.

Ahmeexnal's picture

The rotmof are easily appeased. Let them "win" another sucker world cup.

Cheesy Bastard's picture

Lol.  Kicking balls vs. Kicking ass.

TruthInSunshine's picture

Sarkozy & Bernlusconi & Merkel had a summit today, and they talked, and their words were delicious and soothing, filling the air with hope & cheer, and they said there will be no defaults of any Euro Member, the EUR will be supported, and they will magically make all the debt crises and vexing math problems go away immediately.

So, it's fixed.

They fixed it. They fixed all the problems.

Growth can resume now, and debt is no longer an issue, nor is the tension between those in stronger EU Member States and weaker ones, nor is the strength/weakness of the EUR given that trillions of fresh EUR will be printed and distributed if these dear leaders are to be taken at their word.

They're very competent.

I Am The Unknown Comic's picture

"turkey" is one of the Germanic languages.  Gobble, goggle, peas, gobble gobble. 

Problem solved

G-R-U-N-T's picture

""turkey" is one of the Germanic languages. Gobble,goggle,peas, gobble gobble."

If indeed the ECB turkeys leaves Germany holding the bag then talking "turkey" may very well end up a language of the past.



TBT or not TBT's picture

They gotta get The Won in there too.

Michael's picture

The fatal flaw is, no one is ever again going to buy Credit Default Swaps because they know they will never pay off because of government and central banking cartel shit.

That also makes the holders of those CDO's very angry since their CDO holdings are now worthless. 

I hope they didn't get some billionaire CDO holders angry by doing this. They may put a hit squad out on the people who did this like they did to Scarface.

Michael's picture

I'm not taking the Blame for the Climate Changing or the Weather. The blame is all on them.

I'm only to blame and take responsibility for all the crap I pulled in my 50 years of life. Not the climate changing or the weather. Got IT!

Bang Dae Ho's picture one is ever again going to buy Credit Default Swaps because they know they will never pay of...

Michael, I thought CDS are one more trading instrument, well- OTC trading, but still trading... Long CDS positions are profitable when the sovereign debt crisis soap heats up, and short CDS positions are profitable when it cools down, as recently. When TPTB are positioned long, they give governments and media the order: Drama, drama, please! Then, when they got enough, they take short CDS positions and order: Conference and agreement, please!

I thought nobody is ever seriously considering the 'Credit Default' event, such a hypotetical event is just a pretext to justify this kind of ponzi derivative.

Am I so wrong?

Michael's picture

A hypotetical event that will never materialize, over their dead bodies.

That kind of hypotetical event?


Bang Dae Ho's picture

over their dead bodies.

I also have bold dreams, but I am afraid they are not as bold as yours.


Michael's picture
US panel votes to bar climate funding

"A panel of the US Congress on Thursday moved to bar foreign assistance related to climate change, defying President Barack Obama's calls to contribute as part of an international accord."

"On a party line vote, the Republican-led House Foreign Affairs Committee voted to ban in next year's budget for Obama's initiative to support poor nations in adapting to climate change or pursuing clean energy.

But the measure's future is uncertain as other committees also have jurisdiction over climate funding including in the Senate, where Obama's Democratic Party is in control."

Michael's picture

This site got 791 comments on its most recent thread;


"To address the main issue that people have been getting all bent out of shape about: the stores I photographed do not appear to be authorized Apple sellers."

Are you listening, Steve Jobs?

boooyaaaah's picture

If Germany won WW2, Greece being the soft underbelly of Europe, We all would be in the same position today

Unless Germany reassigned the Greeks to Siberia

Which they still may do

Ahmeexnal's picture

Send greeks to siberia. Create palestinian state in greece. That would solve a lot of problems.

Kurdish homeland in germany with berlin as it's capital would also be a good start.

InconvenientCounterParty's picture


WW3 started in 1971 and is close to being won by the US. That is of course, if the fuck-nuts raise the debt ceiling and don't accidentally forfeit.

Cheesy Bastard's picture

Congressional approval not necessary as there were no boots on the ground.

centerline's picture

Along with going "full fiat," Nixon visited China somewhere around that time with what appeared at the time to be full 180 degree in stance towards the communist country.

Not trying to imply anything.  Just putting two "dots" on the board for the fun it.  If we are going to talk about WWIII already having been waged (on-going) via pen and digital 1's and 0's, I don't think the cold war mentality is off the table.

WestVillageIdiot's picture

You are right that it is World War IV but I think for the wrong reasons.  One of the insiders that I always enjoyed listening to was former CIA Director James Woolsey.  He is not a douche like that Leon Panetta that just got thrust into the position.  He has always stated that the Cold War was World War III.  I agree with him on that.  Just add up the American casualties and costs in treasure that went into that debacle. 

The sad part is if you believe the Cold War was World War III you still have to think the next one will be worse.  This is going to result from such huge economic imbalances that it boggles the mind what the casualty figures can be in this one.  The "emerging market" countries should be the ones fearing what is coming the most.  They are always the biggest losers in proxy wars and major conflicts.  This time will be no different. 

Ahmeexnal's picture

This time around, the "submerging markets" (US-JAPAN-EURO) will suffer great devastation.  Fukushima is only the warm up.

Oh regional Indian's picture

Indeed Ahmee. Though this time the entire northern hemi-sphere is at risk through Air and th eentire world through water, ne?

One has to look, not even deeply this time, to see the nuclear pattern showing it's hand.

And I don't buy this surface level, Germany is payign for Italy crap. Germany has had an iron grip on the Eurozone since long before it's inception.



NOTaREALmerican's picture

Re:  He has always stated that the Cold War was World War III.

Wow,  we became a centrally-planned scam state like the USSR in order to beat the Godless commie, so now we have perpetually increasing Big-MIC, perpetual war, and (the new an improved) Big-PoliceState.    


Can't beat a "win" like that.  

Sophist Economicus's picture

Not Funky-Chunky-Monkey-Boy!    Europeans never kill anybody....

Sofa King's picture

Actually, it's more like 62 to 78 million souls...not just the 6 million that we have chosen to commemorate with the special title of Holocaust victims.

francis_sawyer's picture

Has anybody ever sat down & tallied the number of OSCARS statuettes that have been handed out over the years (in ANY category), to films which had the holocaust as either a central, or background theme?..

It sure gives 'We will never forget' an alternate meaning... Why? Easy... Because it's sure to be shoved down our throats by the doting media & Hollywood community at every opportunity...

Cheesy Bastard's picture

All kidding aside, I stand with the Jewish people and thier right to defend themselves.  I will never forget.  I am a Scottish/Irish/Italian mutt, in the interest of full disclosure.

john39's picture

ok, well enough... but what does that mean.  does that mean that the israeli government gets to lock the palestinian people in large open air prisons? Kill civilians whenever they deem it appropriate? institute an illegal blockaide?  lets get real, it was wrong in south africa and it is wrong in Palestine.

Cheesy Bastard's picture

I see by your response to Amish, you are a holocaust denier.  I will say this to you, and all the rest out there.  If I want any more lip from you, I'll touch your vagina.  Bitch.

WestVillageIdiot's picture

Call me Fred G. Sanford because I am the junk man.  I junked your ass for your overreaction.  I didn't see any denials in there.  Perhaps I need a new prescription.  Feel free to junk but freedom of expression sometimes leads to things you don't want to read.  In that instance your a--hole was wound way too tight. 

Cheesy Bastard's picture

You don't need a new perscription, you need better reading comprehension skills.  I clearly stated "in your response to Amish".  If you scroll down you will see said response.  I also addressed to to all holocaust deniers.  Junk away, my friend, to me it is a badge of honor.

WestVillageIdiot's picture

I deny my denial, cheddar illegitimate.  Proceed.

Cheesy Bastard's picture

No prob, 270degreesTownMoron.  God bless!

CompassionateFascist's picture

There's a JewBook somewhere which claims that the Scots are one of the Lost Tribes; they're surely obnoxious enough. If not, CheeseStink, you are a most excellent Shabbatz Goy.

SirPlayomic's picture

Have you ever been to Scotland? Anyway, let's not go down this tribialistic road where we all fight each other and forget who the real enemy is. In case you forgot, the real enemy is the Banks and their politicial puppets.

ArrestBobRubin's picture

And just who do you think owns those banks? Need to see a list of names?

WestVillageIdiot's picture

Okay, I just saw the post of the holocaust denial.  I will now junk myself.  Israel, like any nation, should be questioned for its behavior.  I'm not in to the holocaust denial.  It was a holocaust in the midst of a larger holocaust. 

dogbreath's picture

how do you get the taste of the condoms out of your mouth

TBT or not TBT's picture

That's the nonylphenol ethoxylates on there. Fortunately, while they are lipophilic, and thus active in your mouth, they are aslo hydrophilic too, and can be washed off easily under running water or with a very wet towel...if your sex tactics can be arranged to accomodate.

Milestones's picture

Well said     Milestones

francis_sawyer's picture

How politically correct of you...

As well... I stand behind the right of INNOCENT victims to defend themselves...

As it so happens... I 'feel' that I am an INNOCENT VICTIM of:

- a banking cartel which robs me blindly in broad daylight every day (& laughs at me as they do)

- a complicit media conglomerate (largely run by sympathizers)

- greedy & corrupt politicians who are paid to facilitate


I'll expect MY OSCAR come next March...



Cheesy Bastard's picture

Fluffers, while in the movie business, don't win oscars.

HungrySeagull's picture

Schuld sein Freiheit

Debt is Freedom... I think.