Why The Upcoming Issuance From The European Rescue Fund Will Reveal More Dirt About Europe's Broad Insolvency

Tyler Durden's picture

After it was announced earlier by the EU that it would launch its first bonds under the EFSF and EFSM in January, of which €17.6 billion are slated for Ireland in 2011, and €4.9bln in 2012, it is useful to recall just what the dynamics of this last recourse fund are, and why not all is as good as the EU may want the broader population to believe. Below, we present the thoughts of Knight's Brian Yelvington who has a rather damning view of what this latest development means for the EU: "This latest band-aid solution obfuscates the issue that the EMU needs
the ability to print money and tax across member states in order to
match its common central bank and currency. There might well be a rally in spreads commensurate with what we have
seen for other band-aid like packages over the past two years.  Once the
measure has been revealed to be inadequate by the market, discussions
around size will begin to emerge.  Our view has been that the facility
was flawed from the start and we believe that view has become more
widely held during this most recent spread widening.  Future upsize
discussions will no doubt see the specter of haircuts raised again –
this time more seriously – and this will serve to push sovereign spreads
wider."
In other words, long-term bearish, short-term very bullish. Just like everything else in the battle to preserve the ponzi.

From Knight Capital:

The EU has announced that it will launch issuance out of the EFSF (European Financial Stability Facility) in January.  The EFSF was tapped for a portion of the €85B Irish bailout announced just weeks ago.  Recall the EFSF was a portion of the €750B facility conceived during the May sovereign scare around Greece (€440 in member guarantees, €250B from the IMF, and €60B from the European Financial Stability Mechanism).  The EFSF has not issued bonds before and took almost five months to receive a rating owing to its contribution style funding that depends on CDO-like ratings methodology.

Per the release, the EU will issue €60B in January out of the European Financial Stability Mechanism (EFSM) and the EFSF will issue in late January.  The EU plans five issuances in 2011, between €3-5B each with maturities of 5Y, 7Y, and 10Y and will be Euro denominated.  The EFSF may issue in currencies other than the Euro, but will have like maturities and will seek to raise up to €16.5B in 2011 and €10B in 2012.

As part of our “Three Threats, One Risk” publication in October and the ensuing presentations, we point out that the issuance of a Euro bond without a fiscal (taxation) union causes several problems for the Eurozone.  EFSF bonds are pari passu with individual countries’ own bonds, effectively cramming down traditional sovereign issues in our view.  Thus issuance out of the common facility could have the impact of crowding out traditional sovereign issuance and further squeeze peripheral funding.  We also note that IMF and other international assistance could also subordinate individual countries’ bonds, exacerbating the problem (see page 28 of the attached “Three Threats” presentation for a visual).

Further, the CDO technology that supports the EFSF means that its contribution portion of €440B is not nearly as large as it would seem.  Once a country taps its contributions are negated from the total amount available and its draw from the facility also hits the total available.  The €750B is far from adequate for the funding needs of the EMU periphery and we feel a more substantial package must be made available before the drawdowns of the EFSF reach the point cramdown of traditional issuance becomes a funding problem.  This latest band-aid solution obfuscates the issue that the EMU needs the ability to print money and tax across member states in order to match its common central bank and currency.

There might well be a rally in spreads commensurate with what we have seen for other band-aid like packages over the past two years.  Once the measure has been revealed to be inadequate by the market, discussions around size will begin to emerge.  Our view has been that the facility was flawed from the start and we believe that view has become more widely held during this most recent spread widening.  Future upsize discussions will no doubt see the specter of haircuts raised again – this time more seriously – and this will serve to push sovereign spreads wider.  Political wills will dictate what exactly occurs, but we are not convinced that extensions alone will suffice to make the region stable.  Already European policymakers have made clear that a permanent crisis mechanism may include hits to private sector creditors within their discussions around the European Stability Mechanism (ESM).