Throughout our history it is said that the most effective ponzi schemes are the ones that no one can understand. If you can present a complex ponzi scheme to an investor that is near panic with fear or greed you will be able to run your ponzi scheme. The scheme works as the goal of the investor, either greed or fear, is sufficiently strong to blind him to all but the most obvious of flaws within the scheme presented.
So as we inspect the latest offering from the euro area to resolve the simple problem of insolvency you can’t help but be impressed by the complexity of the jargon encoded solution they are proposing. We still need some detail and the implementation may well disappoint or even collapse but as above this depends on complexity and degree of motivation of the investor.. the investors in this case are soverign wealth funds and solvent banks.
Ill update this note with press and specialist press reports as they emerge. At present the reports are so vague its pretty worthless placing them up..
Here a few press comments:
http://www.ft.com/intl/cms/s/0/b4f9d128-004c-11e1-8441-00144feabdc0.html#axzz1byLugzlX
http://www.spiegel.de/international/europe/0,1518,794288,00.html
http://www.reuters.com/article/2011/10/27/us-eurozone-idUSTRE79I0IC20111027
My brief summary as per the news flow at present is:
1) Bank haircuts on Greece 50% – voluntary and so no cds melt down of an over exposed issuer.
Problem – Italy, Ireland, Portugal? Hair cuts or not..? Portugal has been shut out of debt markets for a year or so now. The market isn’t lending to Portugal so the EFSF must but in reality isnt Portugal another hair cut issue and isn’t Ireland and soon Italy as well?
2) EFSF most likely to be a bond insurance entity. Ie they underwrite a slice of the debt being issued eg by Portugal. They guarante the first 25% of Portugese debt being issued. This way they hope to create liquidity for Portugal’s debt and lower rates paid by Portugal in the primar market.
Problem – 1st if the EFSF is to act as guarantor on a trillion euros of bank and soverign debt wont this exposure need to be on balance sheet of the various underwriting states ie inc Italy and Spain and France, Belgium, etc? Or is a guarantee different to debt? Thus far it seems the balance sheet exposures via guarantees of soverign states (inc the UK through its nationalization program of RBS, LTSB etc) are off balance sheet. The annual loses are booked but the total exposure is not added to national debt. Its note worthy that private citizens and corporates are not given this luxury. One accounting rule for the soverigns and one for the rest of us it seems. Accounting smoke and mirrors. How long will the rating agencies ignore this issue i wonder!!!
2nd problem here on the EFSF is in the implementation of this element of the plan.. will soverign step forward to buy the bonds? Will they want more than 25%? Even if liquidity comes will rates fall or rise? what will the market price these bonds at? Nobody can know as this is the market so there are all sorts of assumptions that this will work here. Keynesians love to assume they can predict and design the future. As recent history perfectly demonstrates their immense arrogance is always proved unfounded.
3) The EFSF also guarantees bank bonds and injects ‘fresh’ capital into the banks.
Problems – 1st we cannot know how much capital will be needed as yet and secondly therefore if the EFSF has sufficient cash to cover this re capitalization. The eurocrats are assuming the cash (debt actually through EFSF bonds – only a few of which have been issued to date) will be enough to cover the banks capital requirements. The note regarding the ‘solution’ leaves the door open to using the EFSF as a guarantor for bank capital raising issues. Ie in the same way as the EFSF can guarantee euro debt they can guarantee bank debt and or slices of equity. This creates the same issue as above re off or on balance sheet.
Summary. The eurocrats have devised a complex scheme to exploit accounting loop holes and regulatory blind spots in an attempt to kick the can for a period longer. The hope is that world wide inflation will eventually erode the debt relative to nominal GDP. ‘Kicking the can’ can be a solution so long as nominal inflation is sufficiently strong and new debt issuance is sub this nominal level. The implementation of this scheme will be very interesting. The rating agencies view will be crucial and equally important how the soverign funds chose to participate or not in this scheme.
The ECB has not participated in the scheme but i cannot believe it will be long before the ECB is forced to monetize debt in the same way the BOE and FED have already done. The anglosaxon printing solutions have taken the pain up front but the euro solution leaves the pain to come. Clearly both solutions are a disaster for the middle classes of these societies but of the two, i suspect, the anglosaxon one is preferable.
Much more to come as news comes forward..
Rich
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