The big wild card right now is how exactly EU leaders plan to leverage the European Financial Stability Facility — the rescue fund tasked with preventing crisis from engulfing Europe.After weekend deliberations, leaders said they had all but decided on a coherent plan for bank recapitalization, but that decisions on the EFSF were far less advanced.
We heard from European Council President Herman van Rompuy yesterday that two plans are currently under consideration. According to Reuters and general market chatter, one is a plan to insure a percentage of losses on peripheral sovereign bonds. The other proposal would utilise a special purpose investment vehicle (SPIV) to attract foreign investors to buy sovereign bonds.
We’ve heard talk of both these proposals before, so here’s an idea of what these plans might look like, and whether or not they’ll work:
Guaranteeing first losses on sovereign bonds:
– This plan would likely insure 20-30% of bondholders losses on sovereign debt holdings, with the aim of inducing them to purchase bonds of struggling sovereigns like Italy and Spain.
– We’re sceptical that such a plan would work. 20-30% guarantees will probably be too insignificant to convince investors to continue purchasing bonds.
Using an SPIV funded by the IMF and private investors:
– An SPIV would be used to induce investors to purchase sovereign bonds on the primary and secondary markets. The IMF could also be included in this plan.
– This idea appears similar to a rumour sparked by a CNBC report last month.
– This SPV will probably take weeks to create, according to Reuters columnist Paul Taylor. Further, it essentially amounts to the rest of the world bailing out Europe, particularly if private investors aren’t so keen on buying sovereign bonds. It would also likely require the IMF to boost its resources.
– However, an IMF backstop to the eurozone as a whole is an attractive proposition, as it implies that the fund will do what is necessary to support a euro rescue. The IMF can act more quickly than the EU and with much less fanfare.
While both plans constitute steps towards a eurozone endgame, both — at least in the forms mentioned above — amount to more than a temporary bandage on a larger problem.