With another full day ahead of this, things could change, but here is how I understand the situation.
In the EFSF “guidelines” there was this little statement
ii) Finance recapitalization of financial institutions through loans to governments including in non-programme countries
It looks like the EFSF/ESM will lend money to something called the FROB which is either short for “Fondo de Reestructuration Ordenada Bancaria” or “Fund for Orderly Bank Restructuring.” FROB already has about €14 billion of debt outstanding and does roll up into total Spanish debt.
So, rather than have the EFSF/ESM lend to Spain, they have chosen to lend to FROB and have FROB do work of taking those loans and “recapitalizing” the banks. Seems a bit strange, but guess Spain can pretend that it didn’t really need the money and this is just for the banks, and the EU can say they met the terms of the guidelines, since technically FROB is part of the Spanish government. I do like that the IMF will be involved in how the proceeds are used. I actually think that is a real positive. It also adds to the perception that Europe is finally committing its own funds and doing it with proper oversight. It isn’t really, but here on Fantasy Island, the fantasies always start out good before taking a twist that no one expected.
Lots of questions
Since the ESM isn’t actually up and running yet, how much of this will be done by the EFSF? The EFSF has not been able to get leverage. Will it be able to leverage these positions? Will someone give them leverage on the FROB lending? If not, then this would potentially drain a lot of the capacity.
Will ESM be able to leverage? Did they negotiate that EFSF will get a banking license? Without some leverage this takes up a big chunk of EFSF/ESM capacity.
What terms will FROB demand? Will they actually get decent terms or will they piddle around and let more rot and fear set in?
What about Spain and Italy? What does this do for their sovereign debt?
In spite of all the talk about a potential bailout and some run up in prices last week, it felt like people doubted anything would get announced. We can debate whether anything is really accomplished by this, but on the surface it looks like enough is being given that bulls can get excited, more short covering can occur, and then the momo hedge funds that have been whipsawed can decide to hop onto this rally because it feels real and they can’t afford to miss it.
So if a Spanish banking crisis is “off the table” where does that leave Spanish and Italian sovereign risk? In theory unchanged, or possibly worse in the case of Spain, but, in this smile, be happy world, maybe the ECB will resume SMP or the bailed out banks will buy more Spanish debt, or maybe everyone will just get excited by risk on, and jump on the band wagon.
Then what about Greece? I believe that this is a sign that Greece will be cut some relief on their existing deal. As I have said for weeks, Germany finally figured out how much it would lose if it pushed Greece to exit, and it has backed down, and will concede enough that no matter who wins the election, there will be a new agreement reached.
Da helicopter boss, da helicopter
All the market will need to add to the risk on enthusiasm is some sign that the Fed remains dovish. I see no reason for the Fed not to act on the 20th, and they might as well telegraph it next week while the market is already feeling good and squeezed (Euro shorts remain at a record). Helicopter Ben can live up to his nickname.
In the meantime, we got more weak data out of China, but there were signs that inflation is abating. Not only does that help Ben in his desire to drop money, but it may encourage China to throw more stimulus money at their problem.
More news may come out before Sunday. We might even have the rally and fade before the markets open on Sunday, but I don’t think people were that enthusiastic about the prospects of anything decisive coming out of Europe this weekend, and this should be enough to add to the rally.
If it turns out that there are more announcements coming, either from the ECB, EU, China, or Fed, then the rally could gain steam.
In the end, Europe is ultimately just going t have to print a lot of money, forgive a lot of debt, or find more ways to lend cheaply to the weak countries, but that might not bother the market for a period of time.
Editor's Note: For more from Peter Tchir, check out TF Market Advisors.
No positions in stocks mentioned.
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