EFSF, We Hardly Knew You…

EFSF is supposedly going to have trouble getting even 2:1 leverage! Yes, that should have been obvious to everyone. We have tried to explain why none of the leverage ideas would work. We even took the step of trying to make it work and showing how many problems there were. Leveraged EFSF has always been a figment of the imagination of some politicians who had just enough finance knowledge to be dangerous.

Eurobonds, another impossible dream, seemed to have finally been shelved by Merkel. Again, they sounded great, but were totally unworkable.

Europe has consistently waited too long to do anything, and while they were busy trying to figure out how to leverage EFSF (in spite of virtually every non-sycophantic structured credit analyst who said it wouldn’t work) the market has deteriorated. A few weeks ago, investors barely wanted EFSF bonds. Now the market barely wants German and French debt.

It is time to face facts. I think there is a solution to the financial war in Europe. It isn’t pleasant, particularly if you are a mediocre bank, but it may work. In the meantime, Europe needs to do something to calm the markets so they can spend a month preparing for orderly chaos in Europe.

The EFSF should announce bonds sales to the Fed. The Fed should purchase 200 billion EUR of EFSF bonds today. They should commit to further purchases of 100 billion in Q1 and Q2 next year. The Fed has been dying to do some quantitative easing and has been looking for a liquidity crisis in need of some liquidity. It has also been looking (quietly) for ways to keep the dollar weaker.

I’m willing to say that EFSF is more of a liquidity problem than a solvency problem. There is limited capital available, and what is out there is not looking for even relatively safe European bonds. I don’t think France is “AAA” but I also don’t see default as anything but a remote possibility for them, so I will view EFSF’s inability to raise money (and there is no way they get to even 440 billion EUR) in this market as a liquidity event. The EFSF should skip dreaming about a trillion. 440 billion Eur doesn’t solve anything, but it can buy 3-6 months at a minimum to keep the markets somewhat stable so a real plan can be put in place.

I am not sure the EFSF wants to do something this simple, but they need to look at the facts and accept the reality that they can barely issue, let alone leverage up. This would give them 200 billion immediately and give the market comfort that they will get their hands on the additional 200 billion as PIIGS bonds mature. 400 billion of fresh new money should be enough to plug some holes while Merkozy and the technocrats finally try to work out some painful, but realistic solutions to the problem.

I am not sure the Fed could buy EFSF bonds, but Ben seems to have fewer restrictions than any other entity on the planet. One of the guest’s that I was on with at Bloomberg TV mentioned that “the Fed wants to print if the market has a sleepless night”. US stocks are down about 10% from the “close your eyes and pretend it works” rally of October 27th. Could the Fed use that as a way to get involved in Europe? If they buy the EFSF bonds, it should stabilize the US stock market for a bit. It is less risky than buying stocks or HY bonds, which might have a more direct impact on stocks, but are more of a mandate stretch. They can buy mortgages, but seriously, what will that do? I think they could justify buying EFSF bonds (at low yields) in an effort to promote market stability and hence employment, and if they do it in Euro’s the combination of “printing” and “buying euros with that newly printed money” should put a lot of pressure on the dollar. In spite of the inflationary risks associated with that, Ben wants the dollar weak so exports can be helped.

While doing this, the IMF should announce that they will take over all the previously agreed to bailouts of Ireland, Portugal, and Greece. The IMF should be able to do it – they seem to have enough SDR’s and guarantees to do it. Rather than calling on money from their members, they should issue bonds and have the ECB buy them. The ECB can buy the IMF bonds. This shouldn’t be too negative for the currency because the Fed actions would more than offset this printing. The IMF can then take care of all the previously agreed plans to those 3 countries, giving the EFSF more flexibility with its 400 billion of fresh money.

I think this is very simple and can only be used to buy time, but the Fed, ECB, and IMF would all be involved showing co-ordination that everyone seems to like. It wouldn’t put pressure on the secondary bond market since they aren’t really issuing and therefore aren’t putting more strain on banks’ already stretched balance sheets. It also seems to be less of a mandate stretch than many other solutions I have read. The IMF saves countries, the Fed does QE, and the ECB does something (ok, the ECB role is less clear, but that has been true from the start of this).

If you could figure out a way for China to play, or China and Russia, the plan would have even more credibility and might buy a few more months. Maybe China would commit buying EFSF bonds – regular bonds, not the leveraged ones that the EFSF couldn’t even bother to do a term sheet for. On a side note, several EFSF members should be fired, replaced or demoted, for their performance. Trying to raise money on something so complex without even a pitch-book is just pathetic and would not be condoned at even the worst run investment bank.

Anyways, it is not a “Grand Plan” but I think would buy time to put in a real solution.

It may be a good time for Greece or the ECB to remind banks that even on Euroclear, bond payments can be made to specific holders and don’t have to go out to all holders – it would be default, but banks don’t hold all the cards.