A few days ago, when summarizing the key weakness of the second European bailout, we suggested that the fatal flaw in the entire package (which is predicated upon the expansion of the EFSF to about €1.5 trillion for full efficacy) are the "82 Million Soon To Be Very Angry Germans, Or How Euro Bailout #2 Could Cost Up To 56% Of German GDP." Specifically, we explained, "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!" Sure enough, as the Telegraph's Ambrose Evans Pritchard confirms, the backlash has now officially begun.
The best analogy I have heard so far about today's European Solution is that EFSF is being asked to do a lot of what TARP did for the U.S. I cannot disagree with that assessment. The EU is clearly pushing it well beyond it's original design. The question that remains to be answered is, who would fund the EFSF? There are stories that EFSF might buy assets from the ECB at cost. It is clearly going to lend to countries at rates that are massively off-market. It may buy debt in the open market? It may recapitalize banks? I am not sure it can have such a broad mandate and get the rating it needs or to get outside investors. What private investor would have lent to TARP? I think for this program to work, Germany and France will have to suck it up, skip the whole CDO methodology and just fund the EFSF directly. TARP only worked (or got the money it needed and was flexible enough) because the U.S. government gave the treasury carte blanche to do what they wanted.
There is only one section of the proposed European Bailout draft statement that is relevant to traders: Section 7, bullet 3 which says: "To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF, allowing it to intervene in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional circumstances and a unanimous decision of the EFSF Member States." Everything else is noise. Europe just legalized its own Plunge Protection Team and off balance sheet Quantitative Easing program with one signature. Good luck trading in this, or any, market which even the politicians now admit is nothing more than a central banking policy tool.
As news comes fast and furious out of Europe, here is Goldman's take on the so far unconfirmed details of the latest Marshall Plan in Europe, which unlike last time comes before the war. Incidentally, Europe just approved debt monetization, only unlike in the US, it will do it off balance sheet, via the EFSF "CDO" SPV. "EFSF empowered to buy in secondary markets with input from ECB; BETTER THAN EXPECTED, PENDING clarification on SIZE and ACCOUNTABILITY; EFSF able to recapitalize banks in non-program countries through loans to governments; BETTER THAN EXPECTED, ditto. IF ALL OF THIS IS CONFIRMED, VERY positive relative to expectations. Particularly the systemic stuff is a big step forward to unconditional mutual help. If sovereign cross-correlation of default is low, ex ante risk sharing helps everyone participating"
Risk is back on in Europe (and thus spilling over to the US), confirmed by both a tightening in PIIGS spreads across the board and a jump in the EURUSD by 100 pips from overnight lows following a rehash of the same old rumor that the EFSF, or Europe's "toxic bank" off the books CDO equivalent, will provide emergency credit for insolvent countries. With the European Parliament summit starting tomorrow at 1pm (moved back by an hour), there is anticipation that Europe will finally present a strong resolution to ongoing problems. The expectations are not lost on Europe itself: as Barroso said "The minimum we must do tomorrow is to provide clarity on the following: measures to ensure the sustainability of Greek public finances; feasibility and limits of private-sector involvement; scope for more flexible action through the European Financial Stability Facility, the EFSF; repair of the banking sector still needed; and measures to ensure the provision of liquidity to our banking system." Unfortunately just like every previous time, Europe will disappoint as there is no holistic resolution that does not involve the default of the PIIGS. In the meantime, as Bloomberg reports, "European officials are considering steps previously rejected by Germany, including the use of precautionary credit lines, to prevent the spread of the region’s debt crisis, a person close to the talks said. Other options up for discussion at tomorrow’s Brussels summit include enabling the main 440 billion euro ($624 billion) rescue fund to lend to recapitalize banks, said the person, who declined to be named because the talks are in progress. Nothing will be decided until leaders convene. Together with a second Greek aid package, the goal is to prove to markets that Europe has the will and the tools to prevent the crisis from engulfing Spain and Italy." With Italy already "engulfed" it shows just how badly behind the curve Europe still is.
The True Elephant In The Room Appears: Trillions In Commercial And Industrial Loans To Europe's Insolvent CountriesSubmitted by Tyler Durden on 07/17/2011 21:29 -0400
With the market's attention over the past year exclusively focused on bank holdings of insolvent European sovereign debt, which as is now well known had been declining for months, many if not all forgot that banks also have credit exposure via far simpler conduits: retail and commercial debt. And as an analysis of the full disclosure in the EBA's second stress test exposes, banks are on the hook for literally trillions in various plain-vanilla commercial and retail loans to individuals and businesses. WSJ's David Enrich summarizes it best: "Friday's test results shed light on another potential problem for Europe's banks: huge piles of residential mortgages, small-business loans, corporate debt and commercial real-estate loans to institutions and individuals from ailing countries. As those economies struggle, the odds of rising defaults grow." Oops.
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 ToxicSubmitted by Tyler Durden on 07/17/2011 20:26 -0400
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.
The schizophrenic EU once again confirms it has forgotten to take its daily dose of Geodon. Reuters reports that banks in the European Union face curbs on how much they can depend on ratings from credit agencies to calculate the size of their capital safety cushions. Michel Barnier, the EU's financial services chief, said he will make the proposals as part of his reform to bring EU bank capital requirements in line with a global accord known as Basel III that will increase the size of capital buffers. "To limit overreliance, we will be strengthening the requirement for banks to carry out their own analysis of risk and not rely on external ratings in an automatic and mechanical way... We will also make other concrete proposals before the end of the year to limit over-reliance to deal with insurance, asset management and investment fund sectors," Barnier also told the European Securities and Markets Authority (ESMA). Translation: banks will be told to .... police themselves. As for the basis of this move, it is all too clear: remove the influence of the ratings agencies on the fact that the European ponzi is unravelling faster than Lady Gaga's costume at next year's VMA. But wait, what about that AAA rating on the "CDO at the heart of the Eurozone." Oh, well, since that's an AAA, they are fine with that. Of course, if the CRA's say enough, and actually slap a rating that is truly appropriate with this reverse synthetic debt contraption, it's game over.
The latest italy contingency stunner comes from Die Welt which has just reported that the European rescue fund will be insufficient to bail out the latest biggest loser in the game of musical ponzi chairs, Italy. As Reuters translates: "The existing rescue fund in Europe is not sufficient to provide a credible defensive wall for Italy," the central bank source was quoted telling the newspaper in an advance text of an article to appear on Monday. "It was never designed for that," the source added." The newspaper said that the rescue fund might have to be doubled to up to 1.5 trillion euros. But it was not clear if it was the central bank source calling for the increase." Doubling the bailout fund is not a new idea and was previously proposed by Nout Wellink of the Dutch Central Bank, although as Die Welt explains, the decision will ultimately be not that of the ECB but of the separate governments. Germany, as a reminder, is already the biggest backstopper of Europe, and is on the hook for €211 billion euros as the primary funder of the EFSF: which just happens to be the CDO at the heart of the eurozone. Should Germany have to add another 200 billion euros to its rescue commitment, Merkel can forget any and all reelection chances, which is funny since just today it was announced that "Chancellor Angela Merkel has stated publicly that she wishes to run again in 2013. This comes as polls show she would face strong challengers from the opposition Social Democrats." Her chances would be roughly zero if German taxpayers learn that the fate of a failed monetary experiment is increasingly more reliant on their direct labor even as the populations of "austere" countries refuse to work and merely subsist on existing entitlements.
America's toothless regulators strike again. JPM, which recently got away virtually scott free with an identical settlement on CDO security fraud that dragged Goldman stock for months back in 2010, has once again exposed its "most favored fraud" status with America's regulators after Reuters announced that the firm will settle a charges of a 6 year long bid-rigging fraud in municipal securities with the SEC... for the princely sum of $35 million.
Not like it matters much, because any bank that is found to be insolvent following the second consecutive European stress test will merely receive more taxpayer funds concealed as an SPV or a CDO or some other "complex" instrument, but for what it's worth Moody's has released a list of banks that it believes will either fail the farce, pardon, test outright, or will be "candidates for additional support going forward." As a reminder, the European Banking Authority (EBA) is about to publish the results of an EU-wide stress test involving 91 banks from 21 countries. The purpose of this exercise was to assess banks’ resilience to adverse external circumstances and to identify vulnerable banks, defined by EBA as banks whose Core Tier 1 (CT1) ratio falls below 5% under at least one of the scenarios included in the stress test. Moody's splits the sample into 4 Groups as follows: Group 1 : investment grade banks (at or above D+/Baa3 ) : 54 banks, Group 2 : non investment grade banks from peripheral countries (Ireland, Greece, Portugal, Spain) : 17 banks, Group 3 : non investment grade banks from other countries (Germany, Slovenia, Hungary, Austria, Cyprus) : 9 banks, and Group 4 : unrated: 11 banks. It is Groups 2 and 3 that are the focus of the analysis and which will be benchmarked against the test to determine credibility. As for the fact that all European banks are insolvent if just one is, just as all of Europe is bankrupt if Greece were to go under, that's a completely separate point.
As ECB Finds Rating Agencies Have Suddenly Found Religion, It Prepares To Flip Flop On Accepting Greek Bond CollateralSubmitted by Tyler Durden on 07/04/2011 20:57 -0400
Well this was unexpected: the rating agencies, for years and years patsies of their highest paying clients, have suddenly found their conscience, if not religion, and adamantly refuse to bend long-standing rules which qualify the proposed Greek MLEC/CDO type rescue as an event of default. Per Bloomberg: "The rating companies have signaled the plan would trigger because it is being done to avoid default, so couldn’t be considered voluntary, and because investors would be worse off than by holding the new securities." The ECB is so confused by this intransigence and unwillingness to bend to the will of the criminal cartel that earlier today the ECB's Novotny was complaining to Austrian TV about this unexpected demonstration of independence: "Debt rating agencies are being much tougher on potential private-sector contributions to Greece's debt woes than in past bailouts, European Central Bank Governing Council member Ewald Nowotny said on Monday. "We are conducting a very difficult conversation with the ratings agencies," he said."This is what we have to try to find: a way that on the one hand certainly involves banks without having this lead to a default as a consequence," he added. "I also must say it strikes me that the ratings agencies are being much stricter and more aggressive in this European matter than they were, for example, in similar cases in South America. I think this is something we will have to think over." As a result of all this sudden uncertainty, Bloomberg now speculates that the ECB will have no choice than to flip flop on its own adamant position of isolating defaulted collateral, and accept Greek bonds even in an event of default: “The ECB cannot remove liquidity from the big Greek banks,” said Dimitris Drakopoulos, an economist at Nomura. “This discussion is a waste of time. The ECB is going to back down in the end -- what can they do?” he added."
Back To The Drawing Board: S&P Says Greek Rollover Debt Plan "Would Likely Amount To A Default Under Our Citeria"Submitted by Tyler Durden on 07/04/2011 07:27 -0400
Last Wednesday we cited from a Reuters report, according to which the last ditch Greek MLEC/CDO rescue operation, would be welcome to S&P and Moody's as "The whole charm of the French model is that it was worked out in a such way that it will be fine with the rating agencies." Because absent a decree of no EOD, the whole thing is pointless. Well, as often turns out, this was yet more wishful thinking on behalf of some bureaucrat, masked as fact. S&P has just come out with the following: "In recent weeks, a number of proposals relating to this topic have surfaced, and the particulars in some cases are evidently still in flux. This credit comment looks at the most prominent of the recent proposals, put forward by the Fédération Bancaire Française (FBF) on June 24, 2011, in the context of our criteria for evaluating distressed debt exchanges and similar debt restructurings (see Related Research below). In brief, it is our view that each of the two financing options described in the FBF proposal would likely amount to a default under our criteria" and specifically: "we believe that both options represent (i) a "similar restructuring"
(ii) are "distressed" and (iii) offer "less value than the promise of
the original securities" under our criteria. Consequently, if either
option were implemented in its current form, absent other mitigating
information, we would likely view it as constituting a default under our
criteria." Goodbye MLEC 2 - as expected you were just as useless as your first iteration back in 2007.
A week ago, Zero Hedge penned "An MLEC In PIIGS' Clothing: The Latest Greek Bailout Proposal Picks Up Where the Super SIV Failed" in which we explained how the current fatally flawed proposal for a Greek bailout is nothing more than a structured vehicle, expected to remain off the books, and much more importantly, expected to not trigger rating agency ire, and kill the entire extend and pretend game: remember - an Event of Default by a rating agency, even a Technical one (completely irrelevant of what ISDA does with Greek CDS) means game over for the European Central Bank and its €2 trillion in "assets", not to mention the western financial system. Now, a week later, the FT's own Wolfgang Munchau explains why our observation of how toxic the "bailout plan" is was rather accurate: "This structure is still not quite so complex as some of the more elaborate CDOs we have encountered in the global financial crisis. If you take some time to work through the arrows and boxes, you see relatively quickly that this complex structure is not a private sector participation at all. Rather it is a private sector bail-out... I have no space for a large drawing with lots of boxes and arrows to explain the complexity of the vehicle, through which eurozone governments want to involve the private-sector banks in its next loan package." Munchau's conclusion: "If this was any other field of human activity, you would go to jail if you accepted, let alone made such an indecent offer." On the other hand, all is fair in love and perpetuating the ponzi Status QuoTM. Our follow-on observation that "The two things that are keeping the Eurozone afloat: an SPV and a CDO" alas appears also to be rather in line. And before the entire financial system collapses upon itself like a cheap lawnchair, this will be fondly remembered as one of the more prudent "rescue" mechanisms enacted to delay the inevitable.
A few days ago, we demonstrated that the latest Greek bailout package is nothing more than recycled MLEC special purpose vehicle designed to cover up toxic assets off balance sheet, like that one that was supposed to wrap up the subprime toxic mess. Luckily that did not happen as all it would do is make the credit crash even more acute when it finally did hit. In the meantime, the other Frankenstein contraption proposed by Wall Street to contain the fallout of the PIIGS bankruptcy, is the EFSF, which also got a facelift a few weeks back, and which is effectively a CDO: the same instrument which caused European banks to now be insolvent after buying up all tranches offered them by Goldman et al in the 2005-2007 period, once US banks realized just how toxic the less than AAA tranches were. It is poetically ironic that the instrument that led to Europe's insolvency is now what is supposed to prevent (temporarily) its plunge into outright default. For all who are wondering what the details of the new and improved CDO at the heart of the Eurozone are, here is Nomura's Nikan Firoozye.