The EFSF: Europe’s Fake Stability Fund

by Mitch Feierstein about 11 years 8 months ago

As this blog has predicted since its inception, S&P has chosen to downgrade numerous European sovereigns, including France and Italy. The former is no longer a AAA-rated country. The latter, tiptoeing towards non-investment grade status.

Those downgrades caused relatively little market turbulence for two reasons. First of all, S&P was merely catching up with market realities. Indeed, to be more accurate about it, S&P have not yet caught up with market reality, but the gap is smaller than it was. Italian bonds are trading more like junk than like those of a major A+ rated borrower.

The EFSF - An architect's impression

The EFSF - An architect's impression

Secondly, however, the ECB has been piling such humungous amounts of money into the banking sector that short term bond yields can’t help but quieten down. That sea of ECB money has to go somewhere.

So that’s all good news, right? The big Ratings Downgrade has happened and everything’s OK.

Wrong. Here are three reasons why everything is emphatically not OK.

1) Junky collateral
The ECB is now accepting anything as collateral. Anything at all. Greek bonds. IOUs personally signed by Mr Berlusconi. Old toasters. Car tyres. (*) Basically, the ECB wants to hand out soft loans, so it will do anything it can to make those loans available to the weakest borrowers, including accepting collateral that it knows to be poor quality.

2) Short term funding
But the ECB has not completely lost leave of its senses. It’s Bail Out A Dodgy Bank Program only extends money over a three year horizon. No sober government can fund itself solely at such short maturities (though all will have a proportion of short term funding in its mix). So when large over-borrowed governments come to raise huge amounts of long-term money, the market appetite for such debt is likely to be quite different from the placid auctions we’ve seen recently.

3) You can’t put out a fire with gasoline
But last, the ECB handing out loans is the last thing that Europe needs right now. We got into a Debt Crisis because (duh!) of too much credit that created too much debt combined with clueless regulators and politicians only interested in re-election.. Extending the volume of that debt, and at the same time forcing a deterioration in collateral standards, simply exacerbates the crisis. When the ECB’s collateral starts to go bad – and it will – the resultant crisis will be far worse than anything we are now seeing.

Just add wind.

Just add wind.


Which brings us, finally, to the EFSF.

The EFSF was a bad idea from the start. If there’s too much debt, force losses on the creditors whose judgement proved faulty. That’s how it’s meant to work. But, OK, a modest fund to permit certain sorts of reconstruction type activity – I could get my head round that.

But the fund basically aimed to kick the can down the road. To postpone the moment of reckoning, rather than to soothe its passage in the present. Terrible idea number one.

But it gets worse. Bloomberg reports that even since the S&P downgrade, lunatics at the EFSF want to leverage the remaining €440 billion of the fund by some three to four times. So: the problem is excess credit extension and debt. The solution therefore is (A) get Euro governments to pledge hundreds of billions in additional debt, thereby ruining their balance sheets [and remember that the obligations are joint and several, so ALL their balance sheets are maximally impaired.] Then – stroke of genius – (B) add further debt to that debt so that the problem of excessive debt can be deferred yet further into the future … by which point (C) shocking growth data and spiralling interest costs will have compounded the entire problem.

The whole idea is so insane that even the lunatics are laughing. The only real question left: how long before this house of cards collapses? And how catastrophic will it be when it does?


* – Possibly some exaggeration here. I can’t believe it would accept Greek bonds.

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