From Peter Tchir of TF Market Advisors
The EFSF Pitching Itself As A Hedge Fund
There are still so many alternatives on the table and each is so confusing it is hard to come up with a decent analysis. In the meantime, here is something to think about.
EFSF walks into a meeting with a potential investor. EFSF is looking to raise some additional capacity so needs to borrow some money.
The meeting starts off great. The investor is told that EFSF has 780 billion of capital. That is amazing, says the investor, not many people walk through the door with that much capital at launch. The investor is curious as to when the fund will get the funding. For the first time, EFSF looks a bit uncomfortable and has to explain it doesn't really have funding, it just has some guarantees. The investor is a bit confused about this since they would rather have money than guarantees, but decides that if the guarantors are good enough, maybe it's okay.
The EFSF instantly replies that the guarantors are great, they are all highly rated. Well, some of them are at least. Well, actually a few are so weak that they won't actually ever provide the guarantees, they just let us include them in the pitchbook so we could have a bigger number. The Investor is getting a little nervous at this time, but still intrigued, so wants to know how much from the good guarantors? They are reasonably happy that the answer is 726 billion. Still very impressive, but at least a little confused why they bother with the 780 billion. Their experience as investors tells them that when someone lies a little, they tend to lie a lot.
The next obvious question is what are they going to do with the investors money, that doesn't have cash below it, just has some guarantees that would take losses before them. The EFSF proudly announces that it is going to pay as much as possible to prop up weak banks and countries throughout the Eurozone. The investors sit there with stunned looks on their face. The EFSF fully enjoying how awestruck the potential investors are, explain that there are many countries and some banks that cannot receive the financing that they need because they are having cash flow problems, are over leveraged, and quite simply are in deep trouble unless someone is will to buy their bonds at aggressive prices. As the investors finally regain their composure, they are sure they must have misunderstood.
So, your business plan is to go and buy stuff that no one wants, that is unlikely to ever be in position to repay the debt, and you aren't even price sensitive? The EFSF guys are getting very excited, they can tell this investor is on the hook, and now all they have to do is reel them in. They explain that it is even better than that. A couple of the big guarantors are in trouble themselves, but by buying their bonds we help ensure that they don't default. Investor, now wishing they were anywhere but at this pitch, frowns, rubs hand over face, and asks for clarity. Are you really telling me that some of the assets you purchase will be debt of the countries that are providing the guaranty? The EFSF can smell a sale, and explains once again it is even better than that, and reminds the investor that not only will they be buying bonds of some of the countries that are providing the guarantees, but they will also be buying equity stakes in the banks of those countries.
The investor now just can't resist and asks what is going to happen if someone defaults. For the first time EFSF is a bit confused. They had been told this investor was a smart guy and they cannot understand why he would be asking such a dumb question. The EFSF guys do a little wiggle of the head, put on their best perplexed look, and trying keep the disdain out of their voice as they ask what the investor means by default? Investor, now beginning to enjoy this says he really wants to know what happens if something they bought defaults. Now the EFSF guys are getting annoyed. They explain the purpose of EFSF is to ensure these things don't default and besides, the banks and the ECB all own the same stuff so they can't default. The meeting is breaking down now. The investor is starting to get frustrated. No longer any chance of getting involved in this fiasco, but really wants to know what the EFSF plan is if there is a default. The EFSF guys have had enough, this investor is clearly an idiot, but out of politeness, explains one more time if there can't be a default, but if there was a default, they would just get more guarantees. The investor is slowly losing his cool, and demands to know who is going to provide you with more guarantees if the guarantees come from the countries who are defaulting? EFSF has had enough, and says with all due politeness, that clearly this deal is just too complex for you and they will have to go down the street to dumb bank who will instantly see the value of this and subscribe for a few hundred million.
Investor is left shaking their head and trying to reach Michael Lewis because they want to be in on the ground floor of the Big Short II.