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Thursday, 27 October 2011

The great Euro bailout that never was

A few years back when the UK last hosted the G20 boondoggle, the mentally deranged prime minister who chaired the meeting reported that the members of the G20 had agreed $5 trillion of stimulus measures.  That is a very big number.  Perhaps it was €5 trillion or £5 trillion, but in reality it didn't matter because the number was just a figure plucked out of thin air to satisfy the journalists and voters.  Most of the measures were not additional stimuli at all but programmes that were already in place such as export credit guaranty schemes or multilateral development banks.  The numerically largest measure involved the creation of SDRs, which didn't actually create any credit or stimulus at all, but was in effect like a bank printing lots of travellers cheques and putting them in a drawer until a customer used some cash to buy them.

I mention this because we are about to witness a similar exercise with the bailout of the euro.  Truly, none of the central political players have a clue, and the EU is putting out more desperate propaganda (e.g. "We are getting closer to an agreement" 2 days after the agreement was supposed to have been reached).

The reality is that there is never going to be a successful outcome until the governments change their attitude. Governments overborrowed, and they took that money from the banks.  Now the governments can't repay their loans, so the governments say they will have to write down their loans.  That would leave the banks very short of capital. 

"No problem", say the governments, "you will have to raise some more capital".  But where is a bank going to raise capital when it has 50% of the government backed assets on its books?  If private investors put up the money, they are likely to see their investment wiped out when the government default on the other half.

So who is going to put up the equity?  In the last resort, governments.  And where are they going to get the cash to do so?  From the banks.  You can see where this is going..

OK not the banks.  Let's try Mr Wen Jiabao's fast and easy loan consolidation shop. Cash within the hour and bad credit is no problem.  I don't think so.  And neither probably does Mr Jiabao, who can probably see that he probably wins if he lets the opportunity pass, but he almost certainly loses if he stumps up another penny to support European countries with a bad dose of fiscal diarrhoea.

But, back to the politicians, because the biggest pile of hype has yet to be fully disclosed.  The EU thinks that the banks should takje a 50% haircut on their Greek government bonds.  Fair enough because the current bonds are currently trading at a discount (i.e. for the innumerate at a higher yield than at issue).  A big discount, but hard to measure.  So what does the EU propose?  To swap the current bonds for bonds with a lower face value but a higher coupon. Some of the bonds will be backed by AAA rated collateral (yeah, until the rating on those European governments that haven't been downgraded gets fingered), but rather than taking a hit, it is likely that the position of the banks is unchanged. 

They get a hit in theory but they don't have to pony up any cash, and the yield on the new bonds will likely give the same value as the lower yield bonds they replace.  So what is the point? Beats me, but I guess Hermann Van Rompuy, and all the European leaders are none the wiser too.

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