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Thursday, 27 October 2011

Hooray, there is a €uro-deal: a diluted deal that solves nothing and costs money to “nobody”, until it does.

The ignorant listener to the European government leaders could have the feeling that a deal of heroic proportions has been taken away from the gates of hell.
Prime-ministers, chancellors and presidents are boasting on their achievements and, considering my article D-day (€-day) in Europe on Greece, the deal seems indeed almost more than you could have bargained for.
First, an increase of the EFSF to €1000+ bln is not to be sneezed at. And the large banks’ ‘voluntary’ reduction of the Greek debt by €100 bln to a level of 120% of Greek GDP seems like a big step forwards.
In combination with the demand that European banks need a 9% buffer for their risk-bearing liabilities, it seems at first glance that the financial markets could have a sigh of relief.
The financial markets in Europe seem to applaud this deal by opening substantially higher, but will these feelings of relief last?
As always, the devil is in the details. The FT reports on these details in a thorough article by Peter Spiegel, Stanley Pignal and Alex Barker. Here are the pertinent snips, accompanied by my comments.
European leaders reached a deal with Greek debtholders on Thursday morning that would see private investors take a 50% cut in the face value of their bonds, a deep haircut that officials believe will reduce Greek debt levels to 120% of gross domestic product by the end of the decade.
The agreement, struck after nearly 11 hours of talks at a summit of eurozone leaders, includes a new €130bn bail-out of Greece by the European Union and the International Monetary Fund.
They [European leaders-EL] agreed to increase the firepower of their €440bn bail-out fund by providing “risk insurance” to new bonds issued by struggling eurozone countries – a scheme designed for potential use in Italy – but they did not specify the amount of losses that would be covered by the insurance.
Both Ms Merkel and Nicolas Sarkozy, the French president, said it would increase the size of the fund “four or five times”, but a final number could not be calculated because it was unclear how much money was left in the fund. Most analysts estimate about €250bn will remain after the second Greek bail-out, putting the fund’s new firepower at more than €1,000bn.
Although the details of the deal as outlined by both European leaders and the Institute of International Finance remained vague, officials said that €30bn of the €130bn in the government bail-out money would go to so-called “sweeteners” for a future bond-swap, which would be completed by January.
Some €35bn in such “credit enhancements” were included in the original July deal with the IIF, an association of global financial institutions. In that deal, the money was used to back new triple-A bonds that would be traded in for debtholders’ current bonds.
Whether the new programme would be organised in a similar fashion remained unclear. Such factors as the interest rates and maturities for new bonds are critical to determining how valuable the swap will be for private investors.
Some elements of the package appeared to be based on optimistic assumptions. Under the terms of the deal, Greece agreed to put €15bn it aims to raise from a vast privatisation programme back into the European Financial Stability Facility, the eurozone’s €440bn rescue fund. International monitors have already acknowledged that Greece will struggle to raise the €50bn in privatisation cash it promised earlier this year, but the €15bn is supposed come on top of previous commitments.
Although I printed only parts of it, the whole article is a must-read for anybody that is interested in the Euro-zone.
What can be said about the deal as outlined in this article?
Although the 50% haircut for the banks is officially voluntary, you could ask how much is truly ‘voluntary’ of it? And on the other hands: will all banks take part of it? Or will this be a reason for further delay?
Also it seems that the banks received their guarantee on the future sovereigns that are to be swapped against their current greek sovereign bonds (see the red and bold text). The €30 bln in so-called ‘sweeteners’ seem like a premium for the banks on stepping into the Greek (and possibly future Italian / Spanish) bond swap.
This swap will presumably take place according to the scheme printed in my article of yesterday (see the aforementioned link):
This is the reason that today the banks are screaming for additional guarantees, while being confronted with the EU´s proposal to receive ´voluntarily´ €0.15 in cash and €0.35 in new sovereigns for every €1 of old Greek sovereigns they possess.
This guarantee will almost certainly turn into a future transfer of taxpayer money into the banks, privatizing their profits and socializing the banks' losses on these bonds. It is always easier to grab money from faceless taxpayers than from banks that have gathered a powerful lobby for their interests. 
My main objection against the current solution is that a remaining Greek debt of 120% of GDP, in combination with harsh austerity measures on the already anemic Greek economy is not a winning recipe for restoring economic firepower in the country. It seems that Greece will remain in an economic coma and as long as this takes, the financial markets will be extra aware of the other struggling Euro-zone countries (Italy, Spain, Portugal and Ireland). In this way it seems more like delaying the problems than solving these. The €130 bln won’t help to end the Greek misery.
Then about the increase of the EFSF bail-out fund to €1000 bln; the current plan is that the fund won’t contain any more real money supplied by the EU-countries, but will make usage of leveraged funds, backed by guarantees from the EU-countries. This seems like a cheap solution for the EU-countries, but:
·    When the going gets really tough in Italy or Spain, this €1000 bln, although a staggering amount of money, is nowhere near to ‘enough’ for solving the problems there.
·    We had our share of bad experiences with leveraged funds in the recent past; these won’t cost you much money, until losses start to mount and suddenly they do. This leveraged fund won’t be any different, I’m afraid.
European leaders, and not in the least PM Mark Rutte of The Netherlands, always try to sell these rescue plans as 'free lunches' that won’t cost the Dutch/European taxpayer a cent. When will the lying and cheating finally stop on this subject? There is no such thing as a free lunch and there is no guarantee that won’t cost you money eventually.
Then there is the recapitalization of the European banks to meet the 9% capital demand. Bloomberg stated a figure of €106 bln, of which only €8.8 bln for the French banks. The Dutch banks would not even have to raise new capital for this.
Hey, am I the only person that doesn't believe one bit of this calculation? No, I'm not. Read Mish's very interesting article: Good News for Bears: Torture by Rumor Ends.

And last, but not least, how on earth is Greece going to collect this €15 bln in extra EFSF money, when it even can’t raise the €50 bln in privatization money?? It is like building in the next Greek crisis, in order to solve the current crisis.
So unfortunately, my final conclusion is that this €uro-deal is a diluted deal that solves nothing and costs money to “nobody”, until it does.  

Banks most assuredly need more than 106 billion in recapitalization efforts. The idea that French banks only need to raise 8.8 billion is preposterous.

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