The fudging from European policymakers continues

I read a paper (even posted on this blog, can’t locate it now) which said though Americans are blamed for all the financial jazz, it is Europeans who are masters at the art of financial creativity. This is what you see in the crisis solutions from EU policymakers.

I think Henry Farrell just nailed it by saying the instinct of EU policymakers is to fudge. The solution from policymakers looks innovative at first and markets think crisis is over. Then they look at the details and realise all is just a mask and the face behind is the same.

The so-called Europe Summit produced another of such financial jazz solutions. They released a statement of their new measures. The shorter version is here. A nice report from Citigroup is here

The broad proposals are (from whatever I could understand):

Lowering Greece Debt: An agreement with International Institute of Finance whose members are banks.  There is a voluntary exchange with IIF under which its bank members get a 50% haircut on their holding of Greek bonds. It is called as Private Sector Involvement (PSI) in solving Greece debt woes.  There are expectations that it would lower Greek debt to 120% of GDP by 2020! Just imagine how much EMU has to tolerate for letting Greece become its member. The SGP limit is 60% of GDP and here we are talking about 120% of GDP till 2020! No more details given.

Leveraging EFSF: What led to the crisis is being seen as a solution to the crisis as well. This leveraging of EFSF has been doing the rounds for a while now. From its initial capital of EUR 440 bn it is just about 250 bn right now after giving money to Greece, Ireland and Portugal. These guys are now saying they plan to use this 250 bn or so and leverage it upto 1 trillion. There are two ways to leverage:

  • Using Internal resources: This is really complex. First EFSF gives some money to a member. Say it given EUR 100 to Greece. Now Greece uses this 100 EUR to buy EFSF Bonds worth EUR 100. Since these Now Greece uses these EFSF bonds as credit enhancement to issue its own sovereign bonds. The deal here is as  EFSF Bonds  are guaranteed by 17 member countries it is seen as more secure. Hence, the pressure on yields on Greek bonds would be lower. Crazy structure where things go round and round. Citi says this support is expected to vary between 10-30% of EFSF size which is about 25-75 bn Euros. The leverage here will be for the member who takes the loan. He can buy EFSF bonds worth Rs 100 and issue sovereign bonds worth much more.
  • Using External sources: this is where EFSF gets leveraged. Here the idea is that EFSF will float SPVs ( how I hate the term). EFSF will prvide some seed capital (god knows where the money will come from) and ask sovereign wealth funds (SWFs), international investors etc to invest in this SPV. The money would then be used to deploy in saving EMU countries. Citi report says  offerings to investors is likely to be three (could be more types) depending on the risk return profile. This is just like any company that raises funds:
  • Fixed income investor – gets a fixed return. In case of losses in EFSF, he is a senior holder and does not face any.
  • Mezzanine: get a higher return than fixed income for their participation. Are junior to fixed income holders
  • Equity – Like an equity investior, make the most and are designed to absorb the losses.

  Based on their  profile, investors can choose.

The first leverage option can start but second to take much more time.

Barring the financial alchemy, there are proposals to increase capital at banks and also 10 ways to improve governance at Euro. Am not discussing them as much of is known and is just a repeat.

Overall, we still need to wait for details on the same. May be this one works. They are to come out by 7th Nov. There are reports that EFSF chief Klaus Regling already making PPTs to SWF, China etc to sell its latest jazz record…

Lots of comments on voxeu as well


One Response to “The fudging from European policymakers continues”

  1. EMU policymakers communication policy – hide the important and disclose the trivial « Mostly Economics Says:

    […] come out with some bailout plan and do not disclose important  details. Markets figure out themselves and realize it is all zombie […]

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