Telegraph: European officials are working on a grand plan to restore confidence in the single currency area that would involve a massive bank recapitalisation, giving the bail-out fund several trillion euros of firepower, and a possible Greek default.
German and French authorities have begun work on a three-pronged strategy behind the scenes amid escalating fears that the eurozone’s sovereign debt crisis is spiralling out of control.
Their aim is to build a “firebreak” around Greece, Portugal and Ireland to prevent the crisis spreading to Italy and Spain, countries considered “too big to bail”.
Mish: If that's the plan it, it has failed already. The crisis has already spread to Spain and Italy. In fact, one look at European bank stocks says it has spread to France and Germany as well.
Telegraph: Sources said the plan would have to be released as a whole, as the elements would not work in isolation.
Mish: Lovely. In a typical bicycle wheel if one spoke gets broken the wheel still works fine. In the proposed wheel, if a spoke breaks, the bicycle crashes.
Telegraph: First, Europe’s banks would have to be recapitalised with many tens of billions of euros to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. The recapitalisation plan would go much further than the €2.5bn (£2.2bn) required by regulators following the European bank stress tests in July and crucially would include the under-pressure French lenders.
Mish: Will French leaders and French banks go along? Just last week they were insistent that French banks were well capitalized.
Telegraph: Officials are confident that some banks could raise the funds privately, but if they are unable they would either be recapitalised by the state or by the European Financial Stability Facility (EFSF) – the eurozone’s €440bn bail-out scheme.
Mish: Recapitalized "by the state" means taxpayers. Will Germany, Finland, Austria, and the Netherlands go along?
Telegraph:The second leg of the plan is to bolster the EFSF. Economists have estimated it would need about Eu2 trillion of firepower to meet Italy and Spain’s financing needs in the event that the two countries were shut out of the markets. Officials are working on a way to leverage the EFSF through the European Central Bank to reach the target.
The complex deal would see the EFSF provide a loss-bearing “equity” tranche of any bail-out fund and the ECB the rest in protected “debt”. If the EFSF bore the first 20pc of any loss, the fund’s warchest would effectively be bolstered to Eu 2 trillion. If the EFSF bore the first 40pc of any loss, the fund would be able to deploy Eu1 trillion.
Using leverage in this way would allow governments substantially to increase the resources available to the EFSF without having to go back to national parliaments for approval, which in a number of eurozone countries would prove highly problematic.
Mish: This leveraged proposal with the ECB backing it up has already been rejected by the ECB. Moreover, such a proposal with the ECB taking leveraged risk would be in violation of the Maastricht Treaty.
Telegraph: Gathering turmoil in financial markets has convinced Germany to begin work of some kind of variant of the US plan, despite having initially rejected the notion as unworkable as threatening to compromise ECB independence.
The proposal would be hugely sensitive in Germany as its parliament has yet to ratify the July 21 agreement to allow the EFSF to inject capital into banks and buy the sovereign debt of countries not under a European Union and International Monetary Fund restructuring programme. The vote is due on September 29.
Mish: The current EFSF proposal is sketchy enough already. It will likely pass. However, Merkel may go down in flames because of it. The Guardian notes "Merkel looks sure to win the Sept. 29 vote on the European Financial Stability Facility because opposition parties support the bill, designed to give the EFSF more powers after an agreement by EU leaders in July. However, her job could be on the line if she has to rely on the opposition and fails to persuade rebels from her conservative camp and the Free Democrats (FDP), her junior coalition partners. Opposition parties have said Merkel would be finished politically if that were the case and have threatened to call for fresh elections. If that happened, the ensuing uncertainty would send shockwaves through the euro zone as it tries to tackle its debt crisis."
Bear in mind the above mess pertains to the existing proposal for 440 billion Euros. What would the vote be for a €2.5 trillion proposal?
Telegraph: As quid pro quo for an enhanced bail-out, the Germans are understood to be demanding a managed default by Greece but for the country to remain within the eurozone. Under the plan, private sector creditors would bear a loss of as much as 50pc – more than double the 21pc proposal currently on the table. A new bail-out programme would then be devised for Greece.
Mish: Will the ECB, IMF, and France go along with that? What about the German parliament?
Telegraph: Officials would hope the plan would stem the panic in the markets and stop bond vigilantes targeting Italy and Spain, which European and IMF figures believe should not be in any immediate distress but are in need of longer-term structural reform.
Mish: So here we are, with a half-baked 2+ trillion Euro proposal, highly likely in violation of the Maastricht Treaty, that all 17 nations in the Eurozone would have to approve. Finland, Austria, the Netherlands, and Germany are already balking over various proposals and Finland in particular wants collateral.
This multi-trillion idea is "in hope the plan would stem the panic in the markets and stop bond vigilantes targeting Italy and Spain".
The plan is supposed to pass by November? Really? And the aim is to spend 2 trillion to stop something from happening that has already happened.
Hope springs eternal.
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