Two revealing quotes on the EFSF insuring sovereign debt…
The first, via the WSJ:
“It is a system we already know functions well and could encourage foreign investors to come back to the euro zone, and it can be a deterrent form of leverage,” the senior French official said. “The principle of a deterrent is that the threat is greater than the action. It’s like in chess or in the military sphere—and it’s also true in finance.”
Assume for a moment a risk coverage [amount of bond principal insured] of 40 per cent for Greek, Irish and Portuguese bonds and 20 per cent for Spanish and Italian issues: one could fund 4.5 times the guarantees, leading to a theoretical funding power of up to €3,000bn, which should definitely silence market criticism about lack of firepower and end speculation. All of that would be on a purely unfunded and contingent basis, without increasing guarantees beyond what has already been decided. Indeed, with a bit of luck, not a cent would need to be spent.
The EFSF would be insuring a sovereign which may already need a haircut of more than 60 per cent, with very few assets to provide as collateral upfront. The collateral you do have is highly correlated in terms of credit quality.
Really? Not spending a cent? An invincible deterrent?
FT Alphaville can think of at least one person who would enjoy living in this collateral-lite world..
And on the subject of deterrents.. well..
(We’re not even going to go into the fragmentary consequences of insuring new holders of, say, Italian debt while leaving out the old creditors, many of which will have pledged the bonds as collateral elsewhere. Differential treatment in sovereign debt is a big no-no. Merely one reason among many why this isn’t just another French opportunity to wave around their force de frappe…)