Why The Latest European Bailout, Aka "The Debt Buyback" Plan Is Also DOA, And Why The CDO At The Heart Of The Eurozone Is About To Become Extremely Toxic

Tyler Durden's picture

Over time many have wondered why the ECB, in order to "extend and pretend", does not simply do an episode of QE and monetize bonds outright? Well, in addition to Germany's flashbacks to hyperinflation which have so far kept Trichet from pursuing an all too aggressive bond buyback program in the primary market, the ECB does have the Securities Market Programme (SMP) which however since inception has bought only €74 billion (this week the number is expected to rise, or, if it doesn't, it confirms that now China is directly buying European bonds in the secondary market). The problem with the SMP is that it was conceived as a modest marginal debt buying program, never intended to surpass much more than a few dozen billion in debt. Alas, by now it is becoming all too clear that the ECB will need to monetize hundreds of billions of insolvent PIIGS debt in order to extend and pretend forcefully enough so that a new bailout is not needed every other week. But how to do it without monetizing debt on the ECB's books? Enter the EFSF, or the off-balance sheet CDO "at the heart of the eurozone" which according to the latest iteration of the European rescue package (Remember that most recent DOA plan to rollover debt? Yep - that's dead) is precisely the mechanism by which Europe's own open market QE is about to take place. "European Central Bank Executive Board member Lorenzo Bini Smaghi suggested the EFSF be allowed to provide funds for a buy-back of bonds from the market, where prices have in some cases fallen 50 percent from levels at which the debt was issued. "This would allow the private sector to sell bonds at market prices, which are currently below nominal value. At the same time, the public sector could benefit monetarily," Bini Smaghi told Sunday's To Vima newspaper in an interview." Translated: another market clearing perversion courtesy of the same structured finance abominations that brought us here. The problem, unfortunately, is that Moody's announced nearly two and a half years ago that the whole distressed debt buyback approach is... a dead end, and will lead to the same "event of default" outcome that all the prior bailout plans would have achieved as well (we correctly surmised that Bailout #2 was DOA, about a month before the "efficient" market did). Here is why.

For the toxic CDO to work, the SPV will have to sell the varios BB through AAA-rated tranches to another batch of morons, who will later blame the same rating agency that everyone in Europe is now blasting, for keeping the top most tranche rated AAA. Naturally, those with a lot of other people's money (as opposed to just a little) will go well below the AAA-tranche, and well into BB territory in pursuit of insolvent sovereign debt yield, until such time as the cumulative losses hit 100%, the attachment points become meaningless, and the next and final credit bubble implosion blows up Europe. 

Naturally, this whole plan is predicated upon the continued goodwill of the rating agencies to keep the various tranche ratings where they are instead of downgrading the whole thing to D, which is it true rating if objective cash flow, and loss projections are used. So Europe may want to be a little careful as it conducts open warfare with S&P and Moody's.

But the best thing is that, since the whole thing is off the books, nobody's direct credit rating is impaired, and the ECB can pretend it is not monetizing debt.

The second key point is that the ECB will be able to pretend that it is not engaging in inflationary activities, and during the next ECB press conference, Trichet will have to play even dumber than usual, pretending to be insulted by questions that doubt his inflation fighting capabilities.

The third point is that, as Germany acknowledges, private losses will have to be taken. Although as is now well-known, with the bulk of Greek exposure contained at the Greek bank level, and at various US-based hedge funds, nobody really cares, especially since Greek banks have secondary liquidity conduits that will allow them to remain "solvent" even as they are forced to write down their Greek debt holdings. After all, as long as the ECB continues to provide them with 100 cents on the dollar for insolvent bond collateral, all shall be well, and everyone can continue to pretend the system is stable.

From Reuters:

Wolfgang Franz, head of Germany's "wise men" economic advisers to the government, said the huge size of Greece's 340 billion euro ($480 billion) debt pile meant it was "inevitable and justified" for the private sector to accept losses.

"One possibility would be that the current EFSF euro rescue mechanism swaps -- at a significant discount -- Greek bonds into bonds it issues and guarantees," Franz was quoted as telling Focus magazine at the weekend.

Alarmed by the spread of market jitters over Greece to Italy and Spain, where bond yields have surged in the past 10 days, European governments are struggling to put together a second bailout of Greece that would supplement a 110 billion euro rescue launched in May last year.

Germany is insisting private investors be involved in the second bailout, and Merkel indicated on Sunday that if they did not voluntarily agree to a major contribution now, they might eventually be forced into a more costly solution to the crisis.

"The more we can involve private creditors now on a voluntary basis, the less likely it is that we will have to take next steps," Merkel told public broadcaster ARD without elaborating on what those steps might be.

Three weeks of talks between European officials and the private sector have failed to reach a deal on the second bailout of Greece, but the lobby group representing commercial banks said on Sunday that some progress had been made.

"Progress has been made and the discussions are continuing," the Institute of International Finance said in a brief statement. It said the talks were focusing on "several options related to Greece's financing needs and longer-term debt sustainability".

As expected, the rollover, or maturity extension plan, is now as dead as the dodo, with the rating agencies refusing to back down from qualifying it as an EOD:

Other options on the table include an extension of the maturities of Greek bonds. But German weekly magazine Der Spiegel, citing finance ministry sources, reported at the weekend that a debt buy-back had become the option most likely to attract a consensus.

Greece could cut its public debt by 20 billion euros if it bought back its sovereign bonds at market prices as part of a rescue deal, the magazine said.

The funny thing is that if Europe intends to pursue the buyback path, which is effectively a "coercive" distressed tender and/or exchange offer, it will once again raise the ire of the rating agencies. Because, lo and behold, Europe is not the first to think of this. In fact, as Zero Hedge wrote back in April 2009, when most US corporations were pursuing precisely this "distressed tender" approach to benefit from below par prices on their debt, Moody's came out in March 24, with a piece that said the following:

In recent months, issuers have increasingly been proposing
debt exchanges and tender offers at discounts to par. In many instances,
these proposed exchanges reflect an opportunistic motivation as
financially healthy issuers see a chance to reduce debt levels at
attractive valuations. In other cases, however, the proposals are
being made by financially distressed issuers and the effect of the
exchange is to allow the issuer to ultimately avoid a default event,
whether it is a bankruptcy filing or a missed payment on principal or

Exchanges made by distressed issuers at discounts
to par which have the effect of allowing the issuer to avoid a
bankruptcy filing or a payment default (i.e., "distressed exchanges")
are considered default events under Moody’s definition of default.
However, since whether an issuer would have defaulted absent an exchange
is unobservable, the determination of whether an exchange constitutes a default event is inherently a judgment call. As
such, it is important for market participants to understand the
criteria Moody’s considers in evaluating whether a particular exchange
offer constitutes an event of default.

The critical take
home message here is the subjective determination that Moody's and
Moody's alone will make whether or not a company is to be branded a
Defaulter or not. The implications across the capital structure, in the
case of even one security defaulting, are obviously staggering, due to
legacy limitations on what securities can and can not be held in a given
defaulted corporate issuer by many asset managers. However, whereas the
distressed exchange is much less of a judgment call if one is familiar
with Moody's approaches and criteria for evaluating these events, a
minor addition to the terminology by Moody's could jeopardize the
recently gaining significant popularity phenomenon of open market distressed buybacks. As Moody's says:

All formal debt exchanges and tender offers are candidates for distressed exchanges. Additionally, open market and bilateral negotiated purchases of debt are also possible candidates for distressed exchanges.
While purchases and exchanges are typically voluntary transactions,
they can have the effect of allowing the issuer to avoid a bankruptcy
filing or missed payment and, therefore, constitute an event of default.

evaluating exchange offers, Moody’s interprets the term "debt exchange"
very broadly. For example, when distressed issuers restructure or amend
bank loan agreements which have the effect of allowing the issuer to
avoid a bankruptcy filing or payment default, such transactions will be
classified as distressed exchanges.

And while one may have
been forgiven to assume that this is merely posturing on the side of
Moody's, the rating agency showed it was not bluffing when it assigned a
rating of Limited Default to Hovnanian, following its presumed "debt
exchange." From Moody's Hovnanian release:

Investors Service assigned a Caa1/LD probability of default rating
("PDR") to Hovnanian Enterprises, Inc. ("Hovnanian") following the
company's disclosure in its most recent 10-Q filing that between October
31, 2008 and March 11, 2009, it repurchased approximately $368 million
face value of senior unsecured and senior subordinated notes at
substantial discounts to par. The open market transactions, considered
together, constitute a distressed exchange and a limited default by
Moody's definition. The LD designation signifies a limited default and
also incorporates Moody's expectations of open market transactions at
substantial discounts to par over the next twelve months.

Bottom line: we are certain that within 1-2 weeks the ratings agencies will determine that this latest scheme to "baffle them with bullshit" has failed, but at least it will buy Herman von Rompuy and the other bureaucrats another 2-3 weeks of navel gazing. Unfortunately, the much anticipated miracle will, needless to say, not materialize. Which is why Europe may be able to kick the can down for a few weeks, but in August, with no more "bailout plans" and with its back against the wall, the House of Cards will finally commence toppling in earnest.

Below is the full piece from Moody's which we urge Europe's buraucrats to read promptly before it is too late, which explains "Moody's Approach to Evaluating Distressed Exchanges"

Moody's Approach to Evaluating Distressed Exchanges

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buzlightening's picture

So what you're saying is putting more water behind a broken damn won't seal it?  Keep it from rushing down stream and wiping out all citizens, down stream, in the wake of supreme stupidity?    A broken debt based fiat system and more debt won't fix it?  Gee! Who'd a thunk!

DoChenRollingBearing's picture

Well, this week promises to be another interesting one over there in Europe.  I too will be watching gold, as a more than interested observer.


O/T, but since I got on ZH only some 10 minutes ago I have seen three ads:

-- Ukranian single women (pretty nice looking)

-- Russian single women

-- and the ubiquitous Philippine single women.

Yo, AdSense, I am married dudes!


Make that four!  

-- Colombian single women now at the Home Page...

Tyler Durden's picture

You must have missed the Goldman as a community activist ads then. AdSense has a wicked sense of humor some times.

DoChenRollingBearing's picture

Tyler, you (or AdSense) just made it five!  Must have started when I told some friends (via gmail of course) I started reading In the Plex (Steven Levy), the new book on the history of Google (excellent so far).

-- Chinese single women (from your Home Page)

I am lucky that I even FOUND the right girl to marry, I was a total dork when young (still am).  Where the Hell were all these hotties when I was in college?  Eh?  Huh?

HungrySeagull's picture

I don't get the ads because I use firefox and it's addons it works rather well. It helps to preserve our married life here on zh.


However that one in Houston back in '98 was quite something. Probably be still down there with a posse of children to feed by now.

disabledvet's picture

How come i don't get that one?

At120's picture

For some reason I always get the Filipino mail order bride ad.  WTF?

Hulk's picture

I clicked on the Filipino ad and they all flipped me off! Some things never change...

Pegasus Muse's picture

Don't complain.  You guys get hot singles ads.  I get ads "how to build muscle when you're older". 


Mr Lennon Hendrix's picture

And the soon to be..."American brides!  Get yours online, today!"

MarketTruth's picture

You already can bag an American easily... and it is free. www.plentyoffish.com

slewie the pi-rat's picture

my e-mail order bride's bithday was yest.  (i think;  me being male):  happy b'day, msZ!  please do not hesitate to write or call if you're in your birthday suit!  if you're not too upset, tired, busy, stressed, frightened, or doing something more interesting with someone else, of course.   

fasTTcar's picture

Start using Firefox and get AdBlock.

No ads on any web pages.

DoChenRollingBearing's picture

Nope, will stay with Chrome.

And, I would not mind seeing the Ukrainians and Colombians again, just once more...


The Ukrainian women came back to ZH's Home Page.  Real cutie in the center.



How about that!  Just to the left of this comment box, the Colombians are back too!  Ha!



Yo, when do we see the PERUVIAN girls?


Hulk's picture

Dude, I'm telling your wife! You a gold or platinum member? I'm starting with the zinc membership myself...

DoChenRollingBearing's picture

Ahh, but the real question emerges:

Is zinc cheaper than tungsten?

HowardBeale's picture

Those ads are tailored to the individual IP addresses; they are based on porn viewing habits. I am only seeing ads for "Get[ting] Back to nature in New Zealand (with a sheep shown grazing in a valley).

Goldtoothchimp09's picture

ha...a buddy of mine turned a bull riding machine into a sheep riding machine - you don't want to know the details !

Bob's picture

Considering the ads he's getting, I suspect he's all too well acquainted with those details . . .

Reptil's picture

Hahaha Google Adsense also looks at your browsing history (on google, but also gmail) to determine what kind of ads they show you: I'm getting blanks and etoro consistantly, so I'm either too weird (check) or too dumb. ;-)

Also, results of a search vary depending on browsing history in google. You can check this by putting in a couple of searches in different languages, the results thereafter will mostly be in that language.


It's a good idea to use alternative search engines. Google SSL of course doesn't change anything of your history stored by Google. In the Netherlands if you "google" anything related to nuclear energy, there'll be an ad selling you "atoomstroom" because, according to the ad, it's safe, and CO2 neutral. If you don't, you don't get the "atoomstroom" ads.

Welcome to the matrix. ;-)

morph's picture

Adsense works based on your previous browsing patterns. Clearly it has determined that you are interested in women :-)

You can click the Adsense settings and tell google what your interests are so they will stop serving you these ads.

francis_sawyer's picture

The REAL tell will be when ads for hamsters & habitrails start popping up...

buzlightening's picture

Perhaps with the USDinker dollar, US idiots, will have more success when they raise the debt ceiling, pouring more debt into a broken monetary system..  It all burns to ashes.  If it burns it's not real money!!

Reptil's picture

Let's bring back the age old drowning test; if she sinks, she's the genuine article.

If she floats (plastic, paper), she's excommunicated, all references to her existence removed, and burned at the stake.


Global Hunter's picture

"Greece could cut its public debt by 20 billion euros if it bought back its sovereign bonds at market prices as part of a rescue deal, the magazine said."

I'm going to have to go outside and contemplate that for a few minutes.

defender's picture

Its a great idea, really.  Start with the bonds that you have to redeem, since you have to spend the money anyway.  As you save more money, start buying further out maturities.  Best part is that the bonds that you hold will show up as "assets" and, get this, you can turn around and sell them when you have improved your balance sheet to make (Can you believe this?) a profit.

Utter perfection. 


Coming soon to a banana republic near you.

midnight's picture

Mind your own business already, inbreed rednecks!! Do you realize that due to your actions (rating agencies and U.S. MEDIA), there is (financial) WAR rhetoric escalating between Europe and U.S. ???


Lednbrass's picture

Yes, its entirely our fault that Europe has chosen to continually funnel money to insolvent nations.  It was horrible of us to hand the Germans money to Greece and others.

Oh wait, that wasnt us, just stupid Europeans grown totally dependent on bureaucrats and unable to mount any useful opposition whatsoever.

Be glad its only a brief financial war, your combined incompetent militaries would lose to a single division of our school kids in a real one. Dont blame us, you are failing miserably with minimal assistance.

Hedgetard55's picture

Know what? I don't give a fuck anymore. I have a car with a tank full of gas and a garage, that's my "bug out" strategy. No wife and kids to worry about.

Mr Lennon Hendrix's picture

Gold sold off just below $1600.  Look for it to test support at just below $1550 over the next couple of days....support around $1550  :)

Gold bitchez

Mr Lennon Hendrix's picture

Silver now just sold off too, so you junkers can go fuck yourselves.  This is a volatile trade, and if you can't stand the heat...then at least fight me.  Also, the dollar has a little breathing room this week while the politicians pretend like they won't raise the debt ceiling (although the closer it gets, the more I wonder if Lidsey Williams will once again be right).  Look for almost 77 DXY this week, while PMs and oil test support.

And if you need a visual for where gold support is, my friend 99er is on it.


Prometheus418's picture

Where did you see a silver sell-off?  It went up $.50 in three hours.  Hardly a sell-off in my book.  As I'm reading the chart, it looks like silver has established a pretty solid base over the last two months in the $35-$36.5 range, and is setting up to climb again.

Mr Lennon Hendrix's picture

Right under $40.  It will test support over the next few days.  I have support where you do, $35-$36.

Prometheus418's picture

You might be right- but I think if it cracks $40 before tomorrow morning, we'll see it run closer to $45 before it tests support and finds it right above $40.  If not, it might test again tomorrow.  We'll see.

Ultimately, I don't think it matters though- it's got a long way left to go on the upside.  In a lot of ways, I'd prefer it took the stairs up, rather than the elevator.  Holding the line was not easy this April- didn't sell, but it took a couple of weeks before I could bring myself to buy again.  Now, I'd like to see it climb slow and steady, but it looks like it's resuming it's parabolic/hyperbolic curve.

Mr Lennon Hendrix's picture

We share the same long term thoughts, but short term, this week, it will be all about the DXY pushing to almost 77 again.  This will bring oil lower, and so it will bring silver down too.  But only to their respective support levels, because, yes, they have a long way to go.  I think $500 silver is not out of the question in the next couple years.  The real question of course is, 'what will be the sign in front of the number?'  Because it will not be the $.

Prometheus418's picture

I have no argument with 77 USD, but the inverse correlation has been really shaken up lately- it's entirely possible that we could see 80 USD and $45 silver by the end of the week.  Whatever happens, it's sure to go up and down a lot more.

If the sign in front of the silver price is not the $, and we don't know what it will be, the $500 target is meaningless.  Check silver/franc and silver/yen, and you'll see what I mean.  

Either way, it only means that I'll get more or less oz when I hit the coin shop this week.

slaughterer's picture

Why should gold test support at $1550 this week?

Mr Lennon Hendrix's picture

Because it just sold off right below $1600, and support (which I admit is my technical "level" which means I draw lines through the charts and this is not scientific but what is anymore) is at $1545. 

It has taken massive gains, and it is a volatile trade.  No worries.  Get ready to load up for the ride higher!


midnight's picture

And then the rednecks are delusional as hell. ALL of U.S. is FUCKED, all states and at Federal level, while in Europe only 5 out of 27 are having problems. Only Greece is in SERIOUS trouble. It's the same size of Georgia or Tennessee!

Mr Lennon Hendrix's picture

French and German banks are at risk because they own the bonds of the peripheral countries.  Their GDP/debt ratios are not much better, either.

It's all going down, man.

THE DORK OF CORK's picture

Autistic nonsense

Show me the monkey.


Maybe the ECB needs Steves marketing skills for this one.......

Yes the CPO



disabledvet's picture

Here's your monkey:
I think Europe will be lucky to last thru the week. The problem with all this analysis has been the trillion dollar gorilla called an equity market surge--beyond anything rational vis a vis economic growth. Sherlock Holmes dictates "take away all rational explanations and whatever is left no matter how irrational is the reason." Since we have no massive hyperinflation nor is the US equity market alone in rising in spite of disastrous political policies (think Japan here) it must be in aniticipation of the mother of all credit events namely the EU which if true would be disastrous for EU Incorporated. What we do know is this: there will no bailout of any of the "outlier nations" once they default. That will be because the "center nations" have been in the process of defaulting as well in a "when the Chinese crossed the Yalu it was every man for himself" moment. What the Fed will do should such a "mother" occur is anybody's guess. I know one thing: the IMF doesn't give away money for free--and should the IMF simply apply "the European standard" the implications for a failure of the collective will would be catostrophic and last for generations. To sum up "as any Ranger 'll tell ya': sucks to be you."

Subprime JD's picture

The European CDO will grow and grow alongside with the US Fed Treasury CDO circle-jerk and the Chinese real estate and construction kazaam debt monster until the fiat currency wave runs into the resource constraint wall. Remember, its a fiat currency therefore they can change the rules by fiat. Dont be surprised to see the US treasuries outstanding to grow to $17 trillion plus (not including intragovernmental holdings). The only thing that will stop this debt frenzy will be the energy wall.

Per Obama's budget, he expects US GDP to hit approx $23 trillion by 2021. The Euros and the Asians are all expecting similar if not greater growth projections. And just where will the energy come from that will need to supply this near doubling of world GDP in the next decade? It wont come from anywhere. The only other extend and pretend idea that I see is "digital" or virtual" GDP by way of the internet where products are sold online and remain in the internet realm. So instead of leaving your house to show off your D&G purse, you buy the "net" version and "wear" it on your facebook page. I see online virtual GDP being the next step in trying to find a world of growth.

GOSPLAN HERO's picture

My company is called Appalachian Brides,

Hulk's picture

Give them dentures and they ain't half bad looking...

Mr Lennon Hendrix's picture

It's funny because it's true!

Hulk's picture

One day I was lost on the backroads in Kentucky when I spotted a gorgeous young women on Horseback. I rode up to her and asked directions. Her teeth turned out to be rotten and that my friend is where that line comes from...

Greenhead's picture

They are all extending and pretending.  No one wants to deal with the overload of debt issue at public and private levels.  The beauty of fiat is that when the going gets tough, the tough find a way to issue more fiat.  Roll it all over and do it with 50 year bonds, 100 year if that can be done.  Interest only forever.  Roll, roll, roll your debt...