Wednesday, September 28, 2011

Super-charged eurozone rescue fund won’t solve crisis

by Satyajit Das

Financial Times

September 28, 2011

If, as Albert Einstein observed, insanity is “doing the same thing over and over again and expecting different results”, then one of the latest proposals for resolving the eurozone debt crisis requires psychiatric rather than financial assessment.

One idea entails a restructuring of Greek debt with possible writedowns of about 50 per cent and recapitalisation of the affected banks. The European financial stability facility would increase its size , potentially enabling the fund to inject capital into banks and also support Spain and Italy’s financing needs to reduce further contagion risks.

This could involve the use of leverage to increase the EFSF’s size and enhance its ability to intervene effectively. Under such a plan, the fund would apparently bear the first 20 per cent of losses on sovereign bonds and perhaps its investment in banks. This resembles the equity tranche in a collateralised debt obligation, which assumes the risk of the initial losses on loans or bond portfolios. Under such a plan, assuming the EFSF contributes €400bn, the total bail-out resources would be about €2,000bn. Higher leverage, a lower first loss piece of, say, 10 per cent, would increase available funds to €4,000bn. Under this mooted plan, the European Central Bank would supply the “protected” debt component to leverage the EFSF’s contribution, bearing losses only above the first loss piece size.


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