Eurozone Bailout Availability Goes From €300 Billion to €500 Billion
Why the ESM plan is just the grand plans from last summer and fall -- and bound to fail.
The EFSF (European Financial Stability Facility) has committed €200 billion to the European Stability Mechanism, or ESM.
Depending on how you viewed the rules governing the EFSF, the maximum lending limit set last fall was €440 billion of funding at the AAA level. The EFSF could have provided as much as €500 billion if it weren't so focused on that maximum rating.
So how did we get a figure of €800 billion?
Two hundred billion euros of EFSF money that has already been committed got counted. Yes, this is money Europe has committed (more on how they fund it, later), which helped, but that money cannot be committed again.
They also included €49 billion and €53 billion of loans already made to Greece under other EU programs as part of the firewall. Again, that €100 billion has already been spent, so it doesn't really add anything.
Prior to today, the EU had €300 billion of remaining capacity and had spent or committed €300 billion. Now they have €500 billion of free capacity.
Let's take a deeper look:
Last fall, Greece, Ireland, and Portugal had just over €600 billion of admitted debt (not the guaranteed, hidden kind). So far, they have received €300 of EU commitments. Can we assume that a "bailout" is about 50% of a country's debt? Probably not, but it seems that the first round is less than 50%; as it goes on, the amount grows beyond 50%. It is eye-opening that three countries, with a total of €600 billion of debt, have needed €300 billion of support already – and look likely to need more. Ireland is getting a new, extended payment plan. Portugal seems likely to need more. Greece may need more already to deal with the English law bonds, but in any case will likely draw down more.
So this €500 billion that is remaining has to not only continue to support the existing countries, but in theory, needs to deal with Spain and Italy. With €700 billion and €1.6 trillion, that seems dubious, especially once the mechanics are understood. But before we get to that, let's look at what the EFSF has already done.
The EFSF has committed €200 billion, but so far has issued only €63 billion of bonds (including €9 billion of money market funds).
So the EFSF has to come to market with €137 billion soon. That money only gets the highest ratings if it relies on the guarantees of the top six countries. The risk on this money is mainly taken on by Germany and France. Fortunately for them, these risks don't show up anywhere in their current budgets or debt, but they should. The risks are real.
Thirty billion euros of the EFSF bonds were issued to holders of old Greek bonds as PSI (private sector initiative). In order to account for this "liability" the EFSF needed to create an asset. It did; it lent the money to Greece as part of the bailout. There is some sort of "co-financing" arrangement between the EFSF and Greece that allegedly mimics what the public sector got. If that is the case, the EFSF already has a €24 billion hole (their €30 billion asset has a market value of 20%). Who knows what exactly the EFSF is committing to, but some of it is likely to be equity in banks as part of recapitalization of bad banks. The likelihood of getting all that money back is zero. In fact, with how bad Greece is, and how desperate everyone seems to be to find only Band-Aids, it is more likely they lose 100% than that they recover 100%. So the EFSF's €200 billion is likely to have serious losses, and even today an assessment of the value of their assets versus liabilities would be horrible. We will see whether those losses are shared by everyone, or eventually wind up in the lap of France, Germany, and the Netherlands (Finland already got collateral for much of their EFSF exposure).
So, a good portion of the EFSF's existing commitments are due to lose money, and the EFSF is yet to fund much of the commitments. They will be able to fund it because of their rating, and because the ECB will happily take EFSF bonds as collateral, but following the EFSF more closely is important. At some point in time, someone in Germany will notice that their guarantees have become losses and actually do count.
ESM – Paid-in Capital? Not so much.
Today's press release actually had a lot of numbers, unlike many prior press releases. Conspicuously absent were the amounts of paid-in capital. The timeframe was mentioned, but the amounts were never discussed. One would almost believe that by 2014 the ESM will have its full paid-in capital. Actually, it will, it is just that the amount is €80 billion, not €500 billion. You would like to think that the total paid-in capital will be €500 billion. It won't be. It is only designed to be €80. That is consistent with the 15% minimum target. So once again, ESM will not have much actual capital, and will rely on issuing bonds based on future commitments and guarantees.
This is where things really start to break down.
Portugal, Ireland, and Greece may need more money. Fine, the ESM will either use up capital that has been paid in by all the members, or will issue bonds and fund those requests. These three countries have already "stepped out" and so don't contribute to ESM. Since by then EFSF will have issued €200 billion of guaranteed debt, the total program will be over €200 billion. How much appetite is there if the credit quality of the remaining guarantors continues to get worse? France will have 95% debt to GDP in 2014 if they meet their aggressive targets. That doesn't include losses on their bailout contributions, so it could easily get much worse from that, nevermind from a slowing economy. I think there are real issues with how feasible it will be for the ESM to issue that much debt based on guarantees.
But that isn't the real problem. What happens if Spain wants money? Spain will then "step out." Spain will not fund themselves. They are likely to do this ahead of one of the scheduled "paid-in" capital calls, since it would make no sense to pay in capital once it becomes inevitable that it will need money. The moment Spain "steps" out, what will other countries do? If I'm one of the small, relatively weak countries, I run for the hills. If Spain is stepping out and asking for money, there is almost no chance of the firewall working. So I would keep my money and start protecting myself from the fallout rather than giving away my last bit of money in a futile effort. If Italy needs to tap the "firewall," it is lights out. Not only are Spain and Italy the fourth and third largest "commitment providers," but they have debt that is so big that €500 billion is barely a drop in the bucket. The entire burden of a Spanish or Italian bailout would almost certainly fall on the shoulders of France and Germany as both Spain and Italy would "step out." If Italy tried to remain and play the good technocrat puppet, how long would the market be able to resist selling off their debt based on the new commitments? Probably only until traders could stop laughing at the hubris of Italy throwing money to Spain.
So at some point in the near future there will be about €40 billion of money sitting in the ESM and a bunch of promises from countries failing to live up to existing debt obligations -- and that is the big firewall? The correlation between who is providing the guarantees and who will need them cannot be ignored. This new €500 billion number doesn't exist; it's not just meaningless, it's non-existent if Italy or Spain needs money.
People can take away whatever they want, but unlike LTRO (long term refinancing operation), which had real injections of liquidity, this is just like the July plans from last year and the November "grand" plans. It sounds great -- especially when too many people are willing to blindly forward what the politicians want them to forward -- but it doesn't work in practice.
Editor's Note: For more from Peter Tchir, check out TF Market Advisors.
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