Peter Tchir

Europe – Political Fabrications instead of Economic Realities

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The latest EFSF “collateral” package shows once again, just how wrong Europe has it. Dreams of Eurobonds should be relegated to the trash bin. Fantasies that EFSF will leverage itself up to save Europe should be discarded. The latest outcome of EFSF meetings should be enough to let everyone know that even the people with the money have no clue what to do, and the structure of compromise will never get anywhere. The Greek bond rollover is another example of an overly complex, unwieldy mechanism, that doesn’t do what it portrays. This problem goes back all the way to the first EFSF headlines in 2010 where the headline was great but massively overstated potential funding of the vehicle. After a year of changes, you would think someone, somewhere in Europe, would have decided dealing with facts would be the best way to fix the problem, but instead they cling to fabrications and hopes and unrealistic assumptions.

Let’s start at a basic level. The IIF, the politicians, and anyone else in Europe who can get their voice heard has spoken about the “Private Sector Involvement” requiring banks to take a 21% haircut on Greek Debt. This 21% haircut is now viewed as a real number. That only works in politics, not in finance. A real haircut is exchanging €10 million of Greek bonds and receiving €7.9 million of new bonds, with lower coupons, longer maturity, and less (if possible) seniority. That is a real 21% haircut. In the convoluted world of say one thing, pretend to help, but protect yourself at all cost, that isn’t even one of the solutions the bankers have. Most of the solutions would extend maturity, but would turn a portion of their bonds into EFSF obligations (up in credit quality) and have higher coupons than current debt. The 21% is some number pulled out of a hat based on some Net Present Value calculations. Even if you believed those calculations back in July, you would have to check them out now as rates have moved a lot – both on long dated German/French bonds and on Greek bonds. Anyone who chooses to discuss the “21% haircut” is passing along a political fabrication, not an economic fact, and if Europe wants to fix itself, it is time to deal with economic facts, not political fabrications.

Speaking of political fabrications, let’s look at the “collateral” agreement for Finland. As with every other EFSF announcement, it sounds great, but is short on details, and still needs to be approved by every country. From the details that have been released so far, it is clear that the “solution” is a complex set of rules so that Finland can say they got collateral and the other countries can say that they didn’t really give up much.

Any country that wants collateral has to pay their ESM money up front rather than over 5 years. How many of us forgot that the ESM, the “permanent mechanism” was only going to be funded over 5 years? I had forgotten that the political fabrication was “fully funded permanent vehicle” when the reality was “money dripped in slowly over 5 years”. But that isn’t even the funny part of this criteria – the funny part is Finland is going to borrow the €1.4 billion they have to provide the ESM. Yes the age old solution of more borrowing to fix a debt problem.

It is a bit confusing what happens to the collateral if there is a default. In one version, the collateral isn’t provided to the collateralized country until the original scheduled maturity – a nice little NPV trick to diminish the value of the collateral. Another headline suggested the collateral would become subordinated in event of default. That left me scratching my head, but if anyone could figure out a way to call something collateral, and subordinate it at the exact time it is required, it would be the EFSF. They are also proposing only a small portion of any funding can be collateralized. So the political fabrication is “we provided funds only on a collateralized basis” and the economic reality is “we lent money, against which a small portion has collateral, though we are not sure we will ever get access to that collateral.”

The highlight of the requirement package was that any country that opted for collateral would have to give up some potential EFSF profits. EFSF profits? That is optimistic. Giving up a portion of future EFSF profits is about as punishing as me selling rights to any money I make as a professional football player. It is easy to give up nothing.

Until Europe is willing to address the reality of the situation and take some simple but painful steps rather than complex, unworkable ones, that sound good but do nothing, the problems will increase. If you can read the above and believe that Eurobonds are a real possibility, I have some land in Florida to sell. The countries each have too much of their own sovereignty at stake and at some point shuffling debt around really does nothing, but lower the average credit to the point of collapse.

Copyright © 2011 · Peter Tchir

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