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Thursday September 30, 2010 - 13:33:41 GMT
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European Officials: “Oh please oh please oh please oh please ...”

Really, that’s what this Eurozone fiasco has morphed into – quiet desperation.

Officials -- whether those heading up Eurozone member countries, the IMF, the EU or the ECB -- are all holding their breath and hoping that something they do, some of their economy-restoring and debt-reducing strategies, actually sticks.

The reason they’re holding their breath: the success or failure of these bailout measures are almost entirely out of their control. What will make the determination?

The market, of course.

Think about what happen with the Eurozone stress tests; they were a joke, but they stabilized market sentiment and have thus far kept investor attention aimed elsewhere. Even in the US the tests were a bit sub-par, but they did the job. Anyone who conjured up this stress test idea for Europe was of one of two minds:

1) Either they had a lot riding on a Eurozone implosion and figured there would be no chance the public’s perception of the banking system could possibly improve after digging through very vulnerable balance sheets ...

2) Or they had a lot riding on the Eurozone not falling apart and crossed every finger hoping that they could pull a fast one, assuring the public that banks are sufficiently capitalized and are not dangerously exposed, i.e. there’s nothing to worry about anymore.

We all know that #2 represents the most accurate account of what’s happening. And since the stress tests this summer, things have not improved.

A. Spreads of at-risk government bonds over German bunds are still rising; some have blown out to levels significantly higher than when the market was holding Europe under the microscope in April and May, indicating that conditions in such countries have not improved.

B. Greece, with its adopted austerity measures, is experiencing worse growth and is still plagued with rising debt; it seems as though this failure is being shielded from the financial press as much as possible, and for good reason.

C. Ratings downgrades have been dished out generously; more are likely in the pipeline.

D. Ireland and their struggles with keeping their banking system functioning (i.e. bailing out the big boys) are an indication of what is likely simmering in several of the fringe Eurozone economies. Austerity measures, like in Greece, have not worked out nicely for Ireland either.

E. Sovereign debt exposure among the larger Eurozone banks remains extremely large and vulnerable to debt restructuring; if things don’t improve soon and quickly then losses could wreak havoc on these banks and the functioning of the banking system.
All this brings us to one item in particular that’s getting some attention of late – EFSF.

The EFSF is the European Financial Stability Facility. Recent commentary from Leto Research had this to say regarding the state of the EFSF [our emphasis]:

“But, apart from the individual governments’ difficulty in convincing markets of their ability to enforce austerity, a larger problem is looming over Europe: the growth-killing effects of the austerity measures already in effect.

“This larger problem has triggered a new, deeply divisive debate over the future of the EFSF:  On one side, a group of senior Eurocrats with backing from the French and Italian governments are proposing that the EFSF be made permanent; on the other, the German government is adamantly insisting that the EFSF be terminated in 2013 as provided by the initial agreement.

“Furthermore, there is growing market skepticism over whether the EFSF will be at all capable of performing its assigned role if any one country gets in the same predicament as Greece.”

The EFSF is a piece of work, twisted several which ways, aimed at providing financing to those who may need it, funded by those who less-likely need it and some who likely will. Based on all the requirements and details, the amount of loan-able funds is a lot smaller than originally anticipated and the appeal of contributing to the fund is riskier than originally anticipated.

From Satyajit Das, published on NakedCapitalism:

“In order to finance member countries as needed, the EFSF will need to issue debt. The major rating agencies have awarded the fund the highest possible credit rating AAA.
The EFSF structure echoes the ill-fated Collateralised Debt Obligations (”CDOs”) and Structured Investment Vehicles (”SIV”). The Moody’s rating approach explicitly draws the analogy and uses CDO rating methodology in arriving at the rating.

“The Euro 440 billion ($520 billion) rescue package establishes a special purpose vehicle (”SPV”), backed by individual guarantees provided by all 19-member countries. Significantly, the guarantees are not joint and several, reflecting the political necessity, especially for Germany, of avoiding joint liability. The risk that an individual guarantor fails to supply its share of funds is covered by a surplus “cushion”, requiring countries to guarantee an extra 20% beyond their shares. A cash reserve will provide additional support.”

Das also writes:

“At this stage, the EFSF have indicated that they don’t plan to issue any debt, as they do not anticipate the facility being used. The facility also has a very short maturity, three years till 2013. The importance of these factors in the grant of the preliminary rating is unknown.

“S&P correctly inferred that the “EFSF has been designed to bolster investor confidence and thus contain financing costs for Eurozone member states.” The agency indicated that if its establishment achieved this aim then the EFSF would not to need to issue bonds. However, if as pressures mount and market access becomes problematic for some Eurozone members, then the EFSF and it structure will be tested.”

Oh please oh please oh please oh please work. The EURUSD pair says it is working ... but the jury is still out.  

John Ross Crooks III
Black Swan Capital LLC


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