Under the Geithner Plan for Europe, Who gets the losses?

As US Treasury Secretary Tim Geithner attempts to export his plan for creating the European equivalent of a leveraged TARP to buy sovereign debt and recapitalize the banking system, the question arises:  Who gets the losses.

Under the current Geithner Plan, the ECB would lend money to the European Financial Stability Fund (EFSF).  If the ECB is following the advice of Walter Bagehot, it would lend money to the EFSF only against good collateral.

Said slightly differently, the ECB would not take on any risk of loss on its loans to the EFSF.  This limits the potential for the EFSF to absorb losses to the 400+ euros that the EU countries invest in the EFSF.

Any losses above this level would have to be absorbed by the ECB.  Were this to occur, the ECB would need to be recapitalized by the EU countries which may or may not be able to afford their share of the recapitalization.

Under the Geithner Plan, the EFSF would recapitalize the banks.  This suggests that the banks realize the losses on the assets on their balance sheets first.  By recognizing the losses first, the bank's equity is reduced.

If the bank's equity drops to zero, then the bank's unsecured bond holders should absorb losses.  In 2009, the decision was made that the unsecured bond holders would not absorb losses.  Naturally, this created the problem we now refer to as 'moral hazard'.  Ending moral hazard would require the unsecured bond holders to absorb losses.

If the bank's equity drops to zero and the unsecured bond holders are written down to zero, we reach the point where governments would need to step in to protect the insured depositors.  Who is responsible for these losses?  The EFSF or the host countries?

Remember, absorbing these losses does not leave the bank with any capital.  Presumably, the EFSF would be called on to add capital.

All of this assumes that the bank's assets (including sovereign debt, real estate loans and toxic structured finance securities) are really going to be written to market value.

I make this assumption because if the Geithner Plan does not involve writing all the assets to market value, then how are market participants to know if the banks are solvent or not.  If market participants do not know if a bank is solvent or not, then why implement the Geithner Plan because it does not fix the problem?

If Europe's banks are really going to write their assets to market value, are the banks in the US and the UK still solvent?

As I have said since before the credit crisis began, the only way to address the solvency issue is to start with disclosure.  It is only when everyone has the facts that a solution which really ends the solvency crisis can be found.