Another day, and another plan to save the eurozone.
Via CNBC:
European officials are working on a detailed plan aimed at shoring up European bank stability, according to an official who spoke with CNBC’s Steve Liesman. The plan appears to have a lot of moving parts.
It would involve money from the European Financial Stability Facility (EFSF), a bailout vehicle created in 2010 to alleviate the sovereign debt crisis in Europe, to capitalize a special purpose vehicle that would be created by the European Investment Bank, a bank owned by the member states of the European Union.
The special purpose vehicle would issue bonds to investors and use the proceeds to purchase sovereign debt of distressed European states.
And what do you know? It’s already being picked apart by analysts and economists.
Deutsche Bank’s Jim Reid questions whether such a plan would have the backing of the Germans, the ECB, the ratings agencies to name but a few.
(emphasis ours)
Also the latest headlines on the EIB’s potential involvement is a surprise. As noted in a DB research piece dated 16 September 2011 by Bernd Volk, the European Investment Bank is a supranational project financing institution which existed long before the eurozone sovereign debt crisis. It has subscribed capital underwritten by all 27 EU Member States. EIB is certainly not a bailout-institution for the Eurozone, and Bernd understands that EIB’s charter currently does not allow sovereign or bank bond buying.
Indeed the EIB has a 2.5 x leverage limit which without us checking must presumably underpin its AAA rating? Would the EIB’s rating be vulnerable if its remit were to be expanded? Whatever happens our colleagues understand that changes to the EU Treaty with regards to the EIB’s mandate would require a lengthy political process. For us it also seems that such political issues could be even greater as it may involve all 27 EU member states rather than just the single-currency ones.
And look, seriously, the EIB? The EIB!? It’s a boring lender to SMEs, clean energy, microfinance, etc. Buying up sovereign toxic waste and levering it at the ECB is a slight departure from this business model. As it stands now, the EIB’s loan book has an extremely low (less than 0.1 per cent) non-performing loan rate. The possible main risk to the loan book is its relatively large exposure to Italy and Spain already, but it’s nothing like on the scale of holding reams of Italian or Spanish sovereign paper. Being forced to load up on this debt because private eurozone banks can’t hold it any more is just a betrayal of a supranational lender that has served the EU very well. It’s also a betrayal of financing private projects in those countries just when they need the EIB’s good credit the most, and face being frozen out of capital markets otherwise.
You can just tell why eurozone officials would be eyeing up the EIB. It’s an AAA virgin so to speak (imagine the EFSF SPV birthing another SPV. It’s simply unnatural) and they’re scrabbling around for an AAA credit like drunks clinging to a lamppost. Furthermore, they must love the EIB because it’s a bank with existing access to ECB liquidity (since 2009 in fact). No need to mutate the EFSF into a bank in its own right, with dubious legality for monetary financing of sovereign debt under the EU Treaties. Oh no, just pull a fast one on the EIB and its EU backers.
Well, it’s simply not on.
Back to the drawing board then. Not that the equity market seems to care. Indices across Europe are sharply higher on Tuesday morning:
To a degree it’s understandable. The idea that Greece will be allowed to default on an orderly basis whilst the ECB makes sure there is plentiful liquidity for the European banking sector and a series plan to put a firewall round the likes of Italy and Spain is clearly a positive for equities.
But does anyone really believe the EU will be able to co-ordinate such a plan?
This man does.
But we have reservations to numerous to mention in this post.
Fortunately, the equity market has some other props, according to traders.
One is end of quarter rebalancing, says Citigroup.
Remember that this year it has been about a recurrent theme of rallying into the month end which has happened in 6 out of 8 months only to be followed by drastic falls straight afterwards at the beginning of the next month. End of August / September is a great example of this in Europe with the estoxx 50 rallying 8% in the last week of the month only to fall by a similar amount in the next week. Monthly asset allocation into the underperforming asset class?
And to continue that portfolio rebalancing theme, some more from Citi.
• Large declines in US and global equity markets in August coupled with bond outperformance could see large monthly asset rebalancing by US pension funds- rotating OUT of bonds and INTO stocks. This may have a profound short term impact on risk assets.
• Here are the monthly results as of Close Of Bbusiness 9/22/11. This assumes that the hypothetical portfolio is 60% equities (split 75% into US equities and 25% international) and 40% SBBIG index.
• The international equities are down 12.6%, the domestic equities are down 7.33%, and the SBBIG index is up 1.68%.
• This implies a 2.6% rotation out of bonds and into equities. Historically speaking this is quite a strong number, though down from this time last month.
• It’s interesting to note that last month, on 8/24, the signal was at 2.77% in favor of equities but by the end of the month it had dropped to 2.02%, after equities strongly outperformed bonds in that last week.
Clutching at straws? Possibly. But as a reason to be to turn bullish on equities (in the very short term) it makes as much sense as the latest fantasy bailout plan.
Indeed, here (via BarCap and Goldman) is what leading German politicians make of Monday’s EFSF II idea.
BarCap:
According to Die Welt, the FDP’s financial spokesman, Otto Solms, argued that any attempt to introduce leverage through the backdoor would lead to the withdrawal of FDP support for the EFSF, as the contingent liabilities for the German taxpayer would rise in an undue fashion.
Moreover, even the main opposition party, the SPD, which so far had signalled its broad-based support for the EFSF reform, has signalled its discontent. The SPD’s speaker on budget issues, Schneider, argued that any introduction of leverage that would not feature explicitly in the EFSF reform bill discussed and voted on this Thursday in the Lower House would be a de facto circumvention of Parliament, and that this would simply be unacceptable to the SPD.
Goldman:
FDP and CSU not fond of further increase of EFSF. Leading figures from the FDP and the CSU, the Bavarian branch of the CDU, rejected any thoughts of a further increase of the EFSF (either directly or indirectly through leverage). FDP general secretary Lindner said that ” the chancellor should make clear immediately that there is no change to the business model of the EFSF”.
Oh dear.
Additional EIB-moaning by Joseph Cotterill
Related link:
Let them eat EFSF equity tranches? – FT Alphaville