Wednesday, 17 November 2010

The European Vortex

It looks like the European Financial Stability Facility is going to be triggered early to help out Zombie Ireland.

The issue is that, following Ireland, there is Portugal and then Spain to take care of.

There is 440 Billions Euros available (probably less given its similar resemblance to a CDO structure). Clearly not enough to bail out everyone. If the EFSF wants a AAA to issue bonds to fund the oncoming bailouts, it will need to overcollateralize to 120% and maintain a cash buffer. It cannot lend against backing of troubled nations. The more countries in trouble, the smaller the pot available for bailing out countries in trouble, simple as that. Given Austria is witholding already its funding for Greece, the entire unity of the European Union is being tested.

For more explaination about the weakness of the EFSF, you can read the excellent article written by Tracy Alloway in FT Alphaville, published on the 27th of September as well as the post by Dr. Constantin Gurdgiev in the link below:

The EFSF game is well summarised by Dr. Constantin Gurdgiev:

"Now, any sovereign with an once of sense now will know that a race to tap EFSF is on. The faster you get to it to borrow from it, the more likely you’ll arrive to the borrowing window before the limits are reached. Portugal, Spain and possibly even Italy are in the race.

This is why the markets have never been easy about the entire EFSF – they know that Ireland tapping into EFSF simply does two things:

It delays the inevitable restructuring of the massive debts accumulated on the Irish economy side – either sovereign or banks or households or any two or all three. EFSF does not remove the need for such a restructuring. It simply delays it.
It signifies an exponential increase in the probability of EFSF acting as a conduit for contagion from the PIIGS to the rest of the Euro area."

European politicians are trying all they can to kick the can down the road with the EFSF. The "only" major issue is that they are running out of road. Structural issues have not been addressed.

The problem for Ireland, has I discussed in my last post is that its financial sector is damaged beyond repair and need additional support. Currently Irish banks are heavily depending on the ECB for their funding, they are indeed truly zombie banks. The issue is that it is such a black hole for Ireland's public finances, that some external support is necessary. As for Iceland, the Irish banks where too big to fail for the country, hence an estimated budget deficit of 32% for 2010.

On the 17th of November Allied Irish Banks Plc (SUB)was trading at 2568 bps, +405 bps on the day, a 18.76% widening...

Ireland faces the same issue than Iceland did in relation to its banking sector. It did not kept its banking sector under scrutiny and now the whole banking sector is taking the country with it in its downfall.

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