MONDAY, OCTOBER 3, 2011
Satyajit Das: Euro-Zone’s Leveraged Solution to Leverage
Yves here. This article is as concise, accessible, and not surprisingly, not at all encouraging evaluation of the latest Eurorescue ruse mechanism.
By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk
If as Albert Einstein observed insanity is “doing the same thing over and over again and expecting different results”, then the latest proposal for resolving the Euro-zone debt crisis requires psychiatric rather than financial assessment.
The sketchy plan entails Greece restructuring its debt with writedowns around 50% and recapitalisation of the affected banks. The European Financial Stability Funds (“EFSF”) would increase its size to a proposed Euro 2-3 billion from its current Euro 440 billion. This would enable the fund to inject capital into banks and also support Spain and Italy’s financing needs to reduce further contagion risks.
On proposal under consideration entails the EFSF using leverage to increase its size and enhance its ability to intervene effectively. Attributed to US Treasury Secretary Tim Geithner, the proposal is similar to the 2007 Master Liquidity Enhancement Conduit (“MLEC”) super conduit which was ultimately abandoned.
The EFSF would apparently bear the first 20% of losses on sovereign bonds and perhaps its investment in banks. This resembles the equity tranche in a CDO (Collateralised Debt Obligations), which assumes the risk of the initial losses on loans or bond portfolios. Assuming the EFSF contributes Euro 400 billion, the total bailout resources would be around Euro 2 trillion. Higher leverage, a lower first loss piece, say 10%, would increase available funds to Euro 4 trillion. The European Central Bank (“ECB”) would supply the “protected” debt component to leverage the EFSF’s contribution, bearing losses only above the first loss piece size.
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