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Thursday, 13 October 2011

EU Rescue Fund: Build It, And "They" Will Come

Source: Allianz. Hat tip: Financial Times
The Zerozone's life and death struggle may be painfully slow, but it's weirdly entertaining. Comical proposals abound as to how far the dwindling European financial stability facility ("EFSF") - now eroded from 440bn to 250bn - might be leveraged to cover the risk of Zerozone countries going bust. Metaphors to date range from 'a burning building with no exit' to holding on to a 'rising balloon', and I've mixed a few more below. 

The latest instalment, as it were, involves a proposal from Allianz, the insurer, that the requisite leverage could be produced by guarantees (see diagram), so that the steadily shrinking 440bn could magically cover €2.9 trillion of shonky southern sovereign indebtedness. A previous proposal involved CDO-style leverage to €4 trillion. Both appear to suffer from the flaws outlined by Satyajit Das: that the credit risk is massively concentrated and the default correlation is high.

This is like watching turkeys fight over who's next at Thanksgiving. Mr Das is not alone in assigning a high probability to the guarantees being called, or 'CDOs' defaulting - the facility is also a giant magnet for recalcitrant Greek bureaucrats, hedge fund managers and bond traders alike. 

The vultures aren't so much circling, as landing and fastening napkins around their necks.

I guess you could say this makes the creation of the facility a self-fulfilling prophecy. And this just happens to be the reason leading Zerozone banks give for resisting requirements that they recapitalise on the back of stress-tests that factor in the risk of sovereign default (French banks complain they would be forced to raise capital at valuations that are too low, but who are they kidding?)

In truth, the banks are just playing for time until the EFSF gravy train finally rolls into town.

That seems to be what banking is all about. 


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