Guest Post: EFSF - Too Small? Too Big? Or Just Wrong?

Tyler Durden's picture

Submitted by Peter Tchir of TF Market Advisors

EFSF - Too Small? Too Big? Or Just Wrong?

One of the few complaints of the most recent Greek bailout was that the size of the EFSF wasn’t increased.  Amazingly, most “experts” immediately claimed that everything about the bailout was great, except that the size of EFSF was too small.  I will ignore the fact that the IIF voluntary restructuring proposal seems to have disappeared into a black hole and just focus on the problems of the EFSF portion of the bailout.

In particular, people have argued that EFSF is too small to have an impact on Spanish and Italian debt if they continue to experience trouble.  That part is true.  An EFSF PIIGY bank of only €440 billion will not make a dent on the yields of Spain and Italy with a combined debt of €2.2 trillion.  And that’s if the entire €440 billion was available for those two countries only, but as we know most of the money will be used up supporting Greece, Ireland and Portugal.  So, EFSF is too small to do anything material to help Italy and Spain, but that does not mean that EFSF is too small.  In fact the EFSF is large, and may be too large already for purposes of France and the Netherlands.

If the EFSF issued the full €440 billion, it would be one of the biggest bond issuers in the world.  It would have more debt outstanding than any corporate I could find.  DB has €370 billion, GS $400 billion, and GE $367.  The fact that EFSF would have more debt outstanding than these massive global companies employing thousands of employees puts its size in perspective.  But even comparing to sovereign credits, ESFS is massive - the Netherlands have only €307 billion of debt outstanding, Belgium €315 billion, Austria €194 billion, and Finland €74 billion.  Do these countries, which provide 15% of the guarantees think €440 billion is small?  Fannie Mae comes with $742 billion of debt outstanding and everyone knows how well that worked out in the end.1

So although the EFSF is too small to have an impact on Italy and Spain, it is actually a very large entity, and would have more debt than almost any corporation and more than most governments.

Under the new plans, EFSF has morphed from a prudent liquidity provider at times of specific need to club member borrowers into a PIIGY Bank that has virtually unlimited powers.  Moreover, the rating of EFSF is now solely based on the coverage provided by the AAA rated governments.  Earlier this year, the structure of the EFSF was changed to allow it to issue up to €440 billion of bonds.  The only way that could be accomplished was to require each government to change their “over-guarantee” to 165% from 120%.  The sum of the guarantees provided by the AAA governments (Germany, France, Netherlands, Austria, Finland, and Luxembourg) total €451 billion.   It is not a coincidence that EFSF debt issuance is constrained by the total guarantees provided by the AAA countries.  With the expanded powers of the EFSF in the latest proposal, it is clear that you cannot rely on the assets of the EFSF to provide value.2   In a rational world, someone would try and figure out the likely worst case value of the EFSF, and then only look to the guarantees to cover the losses.  But, if the credit crisis has taught people anything, it is that rating agencies don’t always live in a rational world.  So once you start looking solely at the guarantees to determine the rating, you run into another one of the rating agencies’ little quirks.  If any part of a potential payment was covered by only a AA rated entity, the agencies would fell compelled to provide a AA rating for the whole amount of debt issued.  That is why to get the AAA rating, the EFSF will need the AAA guarantors to cover the whole amount.  It seems a bit weird, but that is how the rating agencies tend to work.  Though in their defense, relying on the guarantees provided by Spain and Italy to buy their own debt would be a bit convoluted, and you have to assume that in the worst case, where the EFSF has purchased bonds of those countries, and they default, the guarantee provides little comfort.

So now that it is clear that the EFSF is completely dependent on the AAA guarantors, let’s put their EFSF guarantees in some perspective.  The Netherlands’ guarantee is equal to 14% of their existing debt.  Would the market be comfortable if the Dutch came to market and increased their debt from €307 billion to €351 billion.  How comfortable would investors be if they came to market with a €44 billion issue?  That is a big increase in the debt of Holland.  I believe investors would get nervous, and so would the rating agencies.  The EFSF guarantee mechanism and second loss protects the Netherlands, but in the worst case, this is an obligation of the Netherlands.  For Germany their EFSF obligation is 17% of their existing debt, and for already reluctant Finland it would be the equivalent of increasing their outstanding debt by 19%.  These are BIG numbers.  Looking at the guarantees in terms of GDP doesn’t make the numbers less daunting.  Effectively these countries are taking on obligations of about 8% - 9% of their respective GDP’s.  Adding debt of almost 10% of GDP should raise some eyebrows, both for investors and the rating agencies.

The obligations created by the AAA governments are large relative to their existing debt, large relative to their GDP, and are big enough that they could cause real problems for the guarantors if and when they are called on to meet their obligations.  It may even increase their own cost of debt, as the EFSF competes with their own debt amongst bond investors.

Finally, does the EFSF really accomplish much?  One of the most ballyhooed PIIGY bank feature is the ability of the EFSF to buy bonds at a discount and lend money to the country to buy them back, thus decreasing the notional owed by that country.  Let’s say that the EFSF buys €20 billion of Greek 5.3% March 2026 bonds at 60% of face.  So the EFSF spends €12 billion.  In the proposal, the EFSF would now lend Greece €12 billion so that Greece could buy these bonds and retire them.  Greece would have €8 billion less debt outstanding.  That is good for Greece.  The EFSF would have used their guarantees to borrow the €12 billion it needs.  But if the EFSF lends the money to Greece for 15 years at 4%, the market value of that loan has to be less than 60% of face.  The ESFS loan would be longer dated with a lower coupon than the bond that is trading at 60% of face in the market.  That loan has to have a lower valuation.  Let’s say 55%.  So the EFSF borrowed €12 billion and now has an asset with a mark to market of €6.6 billion.  Greece benefits because it got to reduce its debt by €8 billion, but you cannot ignore that the EFSF just did a trade that cost them €5.4 billion on a mark to market basis.  This scheme comes at a cost (or gift), and it is yet to be determined how much the AAA countries are willing to gift to other countries.

There is an even bigger problem with this scheme, and one that limits how much it can really accomplish.  The sovereign bonds of each country
belong to two categories – first is the “free float” or those that are held by entities that have them marked to market, and the second is bonds held in hold to maturity entities and not marked to market.  From the data presented by the IIF, it appears that most of the Greek debt is still held in non mark to market accounts at banks and insurance companies.  The “free float” bonds can be traded around with limited consequence.  The EFSF can purchase these from trading desks or hedge funds (or from hedge funds via trading desks) and not have an impact on the non mark to market holders.  Quickly, the fast money will realize who the ultimate buyer is, restrict the amount of free float bonds for sale, until they extract the maximum possible price from the EFSF.  In the end, even if the EFSF was able to buy all the bonds already in mark to market accounts at a reasonable price, the potential benefit to the countries is limited.  There just aren’t enough bonds readily available in the marked world.  So the EFSF would need to source bonds from the great unmarked pool.  These are the same banks that the EU/ECB/IMF have been trying hard to help avoid losses.  These are the banks that are potentially weak, and may start a contagion among banks.  How can these banks afford to sell the bonds and monetize the loss?  They should be able to, but there is concern that they aren’t capitalized well enough to do it.  If they start selling en masse, the losses have to hit the books of those institutions.  Wouldn’t that trigger a potential run on the weakest banks and potentially unleash contagion?

The EFSF plan to let countries buy bonds at a discount is a true Catch-22 proposition.  If they don’t source many bonds, the benefit to the country is too small to make a difference at the sovereign level, and sovereign contagion risk remains in play. But if they are able to buy a meaningful amount of bonds, those bonds will be coming from banks that had been desperately avoiding taking the mark to market hit, potentially triggering contagion among the banks.  The narrow window where this program might stop sovereign contagion without triggering bank contagion is too small to think that a bunch of politicians or economists will be able to steer the course accurately and that some other unintended consequence won’t rear its ugly head.

  • 1. So many people seem to think more debt is better, that it is probably worth noting that XOM and AAPL have combined market caps of more than $750 billion and have accomplished that with only $7.5 billion of debt between them.
  • 2. It went from making limited, short dated loans, with significant cash holdbacks, and covenants, to basically carte blanche. Many of its activities are guaranteed to provide large mark to market losses at the time of execution – 15 year loans at rates lower than France can borrow at, lending money to buy back discount bonds, and trading against the “speculators” when the EU feels its appropriate.

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Hedgetard55's picture

Since there is no free lunch, this whole convoluted scheme is merely a mechanism to transfer wealth from the stable Eurozone countries to the deadbeats. Sort of like Bubbles Ben transferring my potential interest income to his bankster buddies through ZIRP. Am I right, or did I miss something?

mason5566's picture

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DormRoom's picture

Your analysis ignores China.  China has become the world's PPT.   It willl buy into the EFSF vechicle to ensure Europe's stability, because China's stability depends on it. 


The wolfpack will contend with China soon.


scratch_and_sniff's picture

unintended consequences, i cant work out if thats genuinely funny or if im actually going insane due to too much whack a mole.

Either way, when euro politicians are in the shit, this is who they consult these days...


lewy14's picture

Just wrong, as in that's just... wrong...

knukles's picture

Lemme see here.
The capital contributors to the ESFS are the one and the same EU members.
The ESFS is nothing more than an SVP.
The buyers of the PIIGGY banks debt are gonna be the EU members.
The EU stuffs new money created at the flip of a digital switch from each national central bank member of the ECB or alternatively contributed by a national treasury of an EU member.
Which is put into a SPV that issues debt which will be supported by some form of national, ECB, EU menber guarantees (else nobody'll buy the unrated shit which it would be without the support mechanism).
(For that matter, even with the support mechanism, it's just rated shit, IMHO.)
To turn around and buy the rancid paper of the PIIGGys at a discount to market.
Wherupon, ta-dah, the total notional face value of the PIIGGs debt remains the same as before, meaning that the same interest cost in nominal and real Euros remains the same as it was before, so the true debt burden has not unservicably changed one unservicable iota.  Brilliant!
And any privte entity who sells the stuff at a discount no longer gets to carry it at cost, realizing a loss.  Impairing capital.  Brilliant squared!
But if the ESFS forgives the interst payment on some PIIGGy debt it holds then it is still likely a default across all debt of the same issue, pari passu.
So, the interst cost ramins the same, so what the fuck is who kidding who with all this crap that has been contrived and birthed by numerous politicians scattered aimlessly about 3,000 committees each with its own whothefuckknowswhat hidden agenda other than to kick the can down the road to keep a cushy high paying do naught fuck all job at taxpayer expense, including the US via the IMF portion of the clusterfuck?

Sounds solid to me. 

SwingForce's picture

Hey, where's this money coming from? And where is it going? Does it go straight to the banks to pay of the redemption of the previous bond issue? Well, that would mean no net-new-debt except for interest & fees, so where does the rest of the money go if they are incurring new debt? Banksterz Bonuses? Gov't workerz paychecks? Wow, everybody's getting fat except Mama Cass.

Atomizer's picture

Collapsing all currencies in a strong upward motion is the plan. " We never saw it coming" will be the tall-tale. We still have time to alter the future.. very limited time. Winks.

Manthong's picture

Hmmm.. a sub-prime soveriegn fund.

It worked so well with housing for the crooks and impoverished  here, it's bound to work well for funding crooked and impoverished nations over there. 

They should get Franklin Raines and Barney Frank to help out with it.

Religion Explained's picture

You think they'll securitize it? I'm so all in ...

oogs66's picture

i think the EU is all in, with a 2,3 in hand, and a 4, 7,8,9 showing, non suited.  maybe they will get what they need on the river? :D


Atomizer's picture

Through the window

Its hard not to see these days. Read between the lines, my warning is right in front of you.. You'll thank me in the future

bluehorsesandal's picture

Amazing how many people are fooled (intentionally or not) by such a stupid solutions and plans, particularly those from the sell side and MSM. Few folks out there with minimum intelligence and dignity, Peter Tchir being one of them, are able to spot the amount of rubbish that is being put together. It is not that difficult to get it. It would be much simpler, easier and strait forward to allow a hair-cut clean up throughout the system. Why insist in the same error and make it exponentially bigger by the day. Weak up from the Euro dream (or nightmare) go and move on to the real priorities, social reforms, job creation and investments.  

tradewithdave's picture

Let me see if I can put this in Donk-Fraud terms so that everyone can understand.  I've been building businesses and buying real estate for thirty years.  For those thirty years, I often borrowed the money from the bank.  In 2008 the bank quit lending money for just about anything and if they did the collateral requirements made deals so onerous that the linked to so many other aspects of your base that new deals were destructive to your vested interests.... but wait it gets better.

So, instead of borrowing money from the bank we start buying assets, mainly real estate from the banks.  At least we try to negotiate with them.  But they act really weird like they're not allowed to negotiate.  It takes a couple of months in 2008 to figure out what's up when we realize that they can't mark any of their distressed properties to market so that's why they can't negotiate with us. 

Remember you don't do business for 30 years by making people offers on things.  You make the seller put a price tag on anything and everything before you buy it... at least that's the belief system we've been operating under for entrepreneurial generations... wrong.  Eventually we realize that asking the bank to put prices on things is working against us.  That's when it hits us that the 80/20 rule has now become the 20/80 rule.  You see, it's fairly typical if someone is asking $100 for an item you may offer then $80 for that item as a starting point and then maybe settle on a price of $85 or $90.  That's a typical negotiation, right?  Not in this environment.

That's when we realize that not only is the bank not going to put a price on things, they're not even going to negotiate with us, but it gets way, way better.  We start discovering that we can offer $20 for that $100 item and they will take it.  That's right.  The key is that as long as they aren't asked to price it and as long as we don't engage in a negotiation and as long as we show up with cash, they'll take it about 20% of the time and we only need to offer 20 - 40% of the value.  Of course, value is subjective, but we're talking about very comparable assets; $100,000 properties $40,000 and $1 million properties for $400,000 and so forth.  The key is to base the transactions on rental cash flows rather than price appreciation which is non-existent and frankly unnecessary at these price levels.

So, forget borrowing money and forget negotiating the way you have been taught for generations and start buying for quarters on the dollar.  That's right and that's all we have for the past three or four years.  This story about the ESFS bonds and the range bound aspects of their valuation strategy is the same story as Fannie Mae and the collateralized debt obligations, but there is one key different.  These are sovereigns and these are not simply government sponsored enterprises.  That's why the end game of all this is a roll-up of the TBTF Eurozone banks into an entirely new Euro bond reflection of the U.S. Treasury and the launching of a new "divorced" occidental currency as proposed by Mervyn King and highlighted in numerous blog posts on the site. 

What you're witnessing here is a classic roll-up under a bankruptcy upstreaming model.  It's just a sovereign version of the same idea. Think of it as a Western merger of the USA/Canada/Mexico with Germany/France where the foreclosed upon subsidiaries are the PIIGS.  The cute part of the plan is that via the SDR's "divorce" each sovereign gets to keep their flag, a parade and a novelty coin with their founding father's or queen pictured on the front.  Rather than me buying distressed properties from the bank, it will be the new Occidental SDR purveyors buying distressed countries on the cheap. 

Here's the background...

Dave Harrison


OC Money Man's picture


Winston Churchill warned; “An appeaser is one who feeds a crocodile, hoping it will eat him last”.  Churchill would understand the dynamics of the European and American sovereign debt crisis.  Modern warfare is not about a blitzkrieg of panzers, dive-bombers, and storm-troopers swarming across borders to over-whelm patriotic defenders.  Today’s world dominators sucker their prey into financially destroying themselves from within.  Once the quarry is crippled; the invader walks in and takes control of the victim’s economy on the cheap.  Recently bureaucrats from Austria; Belgium; Cyprus; Estonia; Finland; France; Greece; Ireland; Italy; Luxembourg; Malta; Netherlands; Portugal; Slovakia; Slovenia; and Spain quietly surrendered their sovereignty to Germany.  In contrast, Americans stand alone as the only nation on earth in full rebellion against their government’s dangerous addiction to deficit spending.        

Hitler slyly wrote: “How fortunate for governments that the people they administer don't think.”  Most Europeans did not question the too-good to-be-true claims of the euro when it was first introduced in 2002 as the continent’s common currency.  Overnight, serial debt-defaulters were granted unlimited power to raise huge volumes of cheap capital in the untested euro-bond markets.   Fans boasted the new currency created the largest economic trading group in the world; with 332 million direct users and another 175 million people worldwide who pegged their currency exchange rate to the euro. 

Thomas Jefferson cautioned: “I believe that banking institutions are more dangerous to our liberties than standing armies”; but Europeans don’t study American history.  Germans designed the euro to be dominated by the Frankfurt-based European Central Bank (ECB); who control all money printing and operate the eurozone electronic payment systems.  Member central banks  are allowed to sit on Eurosystem Board, but only as junior members.  With their supremacy of ECB rule-making, Germans implemented banking regulations eliminating reserve requirements for loans to euro members; while increasing collateral requirements against loans to the private sector.  Goldman Sachs and other camp followers gave the local banks access to derivatives; which allowed for astronomic leverage of euro member loans. 

Otto von Bismarck, Germany’s first Chancellor, opined: “When a man says he approves of something in principle, it means he hasn't the slightest intention of carrying it out in practice.”  The nations joining the euro were required to agree “in principal” to abide by strict rules against deficit spending.  It now seems preposterous that after decades of deficit spending, politicians would find the discipline to stop steering money to cronies.  After a nine year binge of borrowing and spending; euro members began defaulting.  Early in the European Sovereign Debt Crisis; euro states announced agreements in principal to solve isolated cases of small countries experiencing “temporary setbacks” with short term loans.  First Greece; then Ireland; then Portugal; then Spain; then Italy; and now virtually every euro member except Germany is experiencing rising financial stress.  The euro-debt burdens are so onerous; defaulting nations have no capacity to ever pay back their bondholding banks; making their banks also insolvent.

Hitler taught: "Economic imperialism, like military imperialism, depends upon power.”  The supposed euro benefits allowed Germany to lure its neighbors into debt traps.  Defaulting euro-members could then chose to either; start a new currency and suffer the same brutal inflationary consequences as Germany’s Weimar Republic after World War One; or surrender to Germany as the only power in Europe with economic size financial wealth to stabilize the euro-system.   In the end, bureaucrats from all seventeen euro-members nations agreed to give control of future bailouts to the European Financial Stability Facility (EFSF), a secretive private bank managed and funded by Germany.  The ESFS has authority to loan money and impose whatever financial conditions it would like on borrowers.  Over the next two years ESFS will bailout Ireland, Portugal, Spain, and their banks.  Austria; Belgium; and Italy will soon follow and France and her banks eventually flirt with insolvency.  The European Sovereign Debt Crisis is over; Germany won.   

Economist John Maynard Keynes advised: “The best way to destroy the capitalist system is to debauch the currency.”  A recent poll conducted for CNN found Americans are so concerned that deficit spending will destroy their capitalist economic system; an overwhelming 74% percent now support hand-cuffing Congress to a Constitutional Balanced Budget Amendment.  The public recognizes that Germany and China with low debt are at full employment; while America with huge debt suffers brutal unemployment.   Germany is acquiring the New York Stock Exchange to increase its economic reach to our shores, while China builds an offensive navy to challenge America’s domination of the Pacific.  The American voter’s hearts and minds have decisively turned against deficit spending; perhaps it is now Congressional crocodiles who should be worried about getting eaten.

snowball777's picture

"...74% percent now support hand-cuffing Congress to a Constitutional Balanced Budget Amendment."

"How fortunate for governments that the people they administer don't think."

"...banking institutions are more dangerous to our liberties than standing armies

"...China builds an offensive navy to challenge America’s domination of the Pacific."

When a man says he approves of something in principle, it means he hasn't the slightest intention of carrying it out in practice.” 

"...Americans stand alone as the only nation on earth in full rebellion against their government’s dangerous addiction to deficit spending. "

Ghordius's picture

Your knowledge about Germany seem profound - a pity you stopped researching so around 1948... Neither the German "Elites" nor the German People are nowadays what you are picturing and your view of the European Union as per now is profoundly skewed...

In short: you are, like many generals, preparing for the last war.

snowball777's picture

Too Small?

Yes, too small to cover the PIIGS nut.


Too Big?

Yes, too big to not cause political troubles in Germany and the other productive EU members.


Or Just Wrong?

Yes, the wrong solution to the core (pun!) problem.


Ghordius's picture

LOL. Yes, I agree, it's wrong, it's the wrong size and it is, at the end, just a bluff. Perhaps it buys a couple of years.

Peak Everything's picture

Let me summarize. They are living beyond their means and they are hoping to fix the problem by borrowing more.

markalister's picture

The American voter’s hearts and minds have decisively turned against deficit spending; perhaps it is now Congressional crocodiles cash loans who should be worried about getting eaten.

markalister's picture

The public recognizes that Germany and China payday cash advance with low debt are at full employment; while America with huge debt suffers brutal unemployment.

markalister's picture

Sorry. duplicate entry.

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markalister's picture

The American voter’s hearts and minds have decisively instant payday loans turned against deficit spending; perhaps it is now Congressional crocodiles who should be worried about getting eaten.