Saturday, October 22, 2011

EU finance minister review variations on strategies that failed to end solvency crisis in 2009

According to a Bloomberg article, the EU finance ministers are reviewing a number of different strategies for addressing the sovereign debt/bank solvency crisis.

So far, the review appears to be covering variations of all the strategies that failed to end the bank solvency crisis in 2009 and resulted in the crisis also becoming a sovereign debt crisis.

An example of failed strategy from 2009 that has been dusted off for Europe is PPIP (the public private investment partnership).  PPIP has been dragged out as a way for Europe to leverage up the European Financial Stability Fund.

In the US, PPIP was a failure from the standpoint of restoring a normal functioning to the market for private label residential mortgage-backed securities.  That market is essentially closed.  For example, the Fed reduced prices across the $2 trillion market by 20% when it tried to sell $32 billion in securities.

PPIP has been good for Wall Street, so it is no surprise that a variation of it has been trotted out for Europe.

It is not at all clear why the European version of PPIP should also not be a failure.  In the US, PPIP put the government at risk for the first loss and the US government provided most of the funds to support the investment.  In essence, the investors were buying a low cost option that the securities were worth at least their purchase price.

In Europe, investors are looking at a situation where when large sovereigns default, they tend to have very large losses on their debt - see Greek bonds currently trading for 30% of par.  If the EFSF is only guaranteeing the first 20% of losses so it can "support" 2 trillion euros of bond purchases, it does not appear to offer the investors that good of a return for the risk.

Alternatively, does the EU expect to enhance the bonds of any country that relies on investors who receive a guarantee from the EFSF by requiring the country to effectively sign over control of its budget?  This includes agreeing to implement austerity and any other structural reforms (including raising taxes) necessary to repay their bonds.  I cannot see this form of indenture-hood being acceptable to any EU country.

Regular readers will remember that under the FDR Framework's blueprint for saving the financial system, the EFSF is going to be highly leveraged.  It is going to insure the deposits in the Eurozone banks.

This is necessary because the Eurozone banks are going to be required to write their assets down to a price where they could expect to sell the asset to an independent third party.  Recognizing these write downs is highly likely to result in every Eurozone bank having a negative book value.

At the same time, every Eurozone bank will be required on an ongoing basis to disclose through a data warehouse their current assets and liability-level details.  This way market participants can monitor the risks the banks take and ensure that the banks stay on a path towards rebuilding their book capital.
European finance ministers are considering setting up a fund to entice outside investors to buy troubled euro-area government bonds, as they struggled over how to tame the Greece-fueled debt crisis, said a person familiar with the matter. 
The investment vehicle was one of two options being weighed, along with using the European Financial Stability Facility to boost the rescue firepower from 440 billion euros ($611 billion) currently, the person said. 
“The principle that we leverage the EFSF with private money is being subscribed by everyone, but the level of success is uncertain,” Dutch Finance Minister Jan Kees de Jager told reporters on the second day of crisis talks in Brussels. “How much can we raise, that is being looked at.” 
Europe’s room for maneuver narrowed yesterday with a report thatGreece’s economy is deteriorating, piling on pressure to build a stronger anti-crisis firewall by a self-imposed Oct. 26 deadline. Measures being considered include a boost in bailout funds to 940 billion euros, deeper writedowns on Greek debt, and a demand that banks increase Tier 1 capital to 9 percent by mid-2012.

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