A Leveraged EFSF Is Pure Poison

Ambrose Evans-Pritchard Daily Telegraph October 18, 2011

Tuesday 18 October 2011 | Blog Feed | All feeds

By Ambrose Evans-Pritchard Economics Last updated: October 17th, 2011

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French banks are vulnerable (Photo: Reuters)

Big snag. If Europe's leaders do indeed leverage their â?¬440bn bail-out fund (EFSF) to â?¬2 trillion or â?¬3 trillion through some form of "first loss" insurance on Club Med bonds "“ as markets now seem to assume "“ the consequences will be swift and brutal.

Professor Ansgar Belke, from Berlin's DIW Institute, said any leveraging of the EFSF would be "poisonous" for France's AAA rating and would set off an uncontrollable chain of events.

"It counteracts all efforts made so far to stabilize the eurozone debt crisis, which are premised on the AAA rating of a sufficiently large number of strong economies. In extremis, it would probably cause the break-up of the eurozone", he told Handlesblatt.

France is already vulnerable. It has the worst budget deficit and primary deficit of the AAA states in Euroland. (Yes, Britain is worse, but the UK has a sovereign currency and central bank. Chalk and cheese.)

Dr Belke said France is already under pressure. BNP Paribas, Société Générale, Crédit Agricole may need â?¬20bn in fresh capital, with knock-on risk for the French state. He warned that France's public debt (Now 82pc of GDP) would shoot up to 90pc of GDP if the debt crisis rumbles on. Variants of this theme were picked up by other German economists in a Handelsblatt forum.

Thorsten Polleit from Barclays Capital said France's banking woes could put "massive pressure" on French finances, but the risks do not stop there. Germany itself is at risk. "The bail-out burdens taken on by the German government could lead to a drastic deterioration of our own debt, and put Germany's AAA in doubt."

Mr Polleit told me Germany's debt was 83.2pc of GDP at the end of last year (higher than France, but the current deficit is much lower). "Of course there is a danger. We are in a tough situation and there is no easy way out."

We will find out soon enough what EU leaders actually intend to do "“ rather than what the European Commission would like them to do. As US Treasury Tim Geithner said "the devil is in the details", not in the headlines.

Chancellor Angela Merkel sought to play down the Grand Plan earlier today. "Dreams that everything will be resolved and dealt with by next Monday cannot be fulfilled," said her spokesman. There is no "big bang" miracle cure.

So far there is an ominous silence from the rating agencies. One has to wonder what they think of apparent plans to use the EFSF for "first loss" guarantees of EMU debt — debt to be upheld by states that may or may not be solvent, depending on the trajectory of the world economy and the trigger-happy reflexes of uber-hawks at the European Central Bank. At the moment the EFSF is a privileged creditor (or so we assume: this is not contractual).

Banks, life insurers, pension funds, and others who bought Greek debt in good faith will take the loss. Only once they are reduced to zero with a 100pc haircut does EFSF debt start to be written down "“ ie, this is "last loss".

The new "first loss" idea inverts the order. The EFSF would take the first hit. That changes everything.

Surely the EFSF deserves no more that BBB rating, or perhaps just CCC, if EU leaders really embark on this course.

The whole discussion has become surreal.

Tags: Ansgar Belke, BNP Paribas, Credit Agricole, EFSF, societe generale, Thorsten Polleit

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