Found a Roubini Gem

By John Ballard

Interpreting a Roubini Tweet is more fun than a jigsaw puzzle.

The EFSF-EIB levered option to create a
bazooka-sized LOLR for PIIGS is a SIV on
top of an existing SIV. So it is a CDO-
squared monster!

Others may be able to scan that message with comprehension, but not me. I had to look it up.

• EFSF


• EIB


• LOLR
  


• PIIGS
  


• SIV
  


• CDO
  

I already knew about PIIGS from previous reading. The acronym stands for Portugal, Italy, Ireland, Greece and Spain, all of which have been in the financial news for some time, but the subtext is all about sovereign debt (or credit, depending on who's talking).

EFSF is European Financial Stability Fund. EIB is European Investment Bank. LOLR is Lender of Last Resort. SIV is Structured Investment Vehicle. And CDO is (are) Collateralized Debt Obligations.  

Got that?
Good.

This is the closest I could find to an explanation that a layman might get his head around.

Doing the Twist could buy some time

YESTERDAY'S strong market bounce was based on the belief that calls for Europe to contain its sovereign debt crisis from Barack Obama, US Treasury Secretary Tim Geithner, IMF managing director Christine Lagarde and just about every other luminary with an oar in the debt-infested waters might actually have worked. The plan that Europe is now working on is about creating confidence in the markets that a Greek sovereign debt default can occur without creating a bond-selling tsunami that engulfs the much bigger Italian and Spanish economies.

It revolves around a potential shuffle of resources between the underpowered fund set up to handle sovereign bailouts, the European Financial Stability Fund, and a 53-year-old development bank in Kirchberg, Luxembourg, the European Investment Bank. If it is confirmed, it will be a European version of Ben Bernanke's US bond market Twist, and, perhaps, the breakthrough global markets have been looking for.

Until yesterday, there was growing fear that poisonous politics and financial pressure were combining to pull Europe inexorably into an uncontrolled sovereign debt meltdown, and the underpowered European Financial Stability Fund (EFSF) was part of the problem. It was set up to provide funds to European Union countries weighed down by sovereign debt, but at either its own funding base of �440 billion or its total spending power of �750 billion (reached after taking into accounts its ability to borrow another �60 billion from the EU itself, and �250 billion more from the International Monetary Fund) is only really big enough to bail out Greece, Ireland and Portugal.

That was the outer limit of the crisis when the EFSF was pumped up. But it has become increasingly likely that Greece will default, and increasingly likely that a Greek default will lead to an attack on the next EU nations in the sovereign debt conga line, Italy and Spain.

If a bond market selloff pushes the cost of Italian and Spanish sovereign debt to a point where it cannot be serviced without actually building the debt loads, the potential size of Europe's bailout is at least �2000 billion, or �2 trillion. And ramping up the size of the EFSF in response to that threat from the stronger EU members led by Germany and France seems to be politically impossible. All 27 members of the EU would need to approve a direct funding increase, and may need to push enabling legislation. In some cases, including Germany's, that could bring the government down. Increasing the amount the EFSF can directly borrow is also opposed by the European Central Bank.

Enter the European Investment Bank (EIB). Set up in 1958, it is a triple A borrower, with a mandate to lend and invest in projects that further the development of the EU. It is owned by the EU nations, and had subscribed capital of �232 billion at the end of 2009.

A European Twist would see the EFSF and the EIB invest capital in a new jointly owned special purpose vehicle. Exactly how much capital would cross from the EFSF is not clear, but it would be substantial, and the special vehicle would gear its capital base by issuing bonds of its own to create a bailout war-chest that could be as large as �2 billion. Sovereign bonds acquired by the special vehicle would eventually funnel back to the European Central Bank through the EIB, which has access to the Central Bank's bond repurchasing window.

Political obstacles to a EFSF-EIB bailout fund are lower than those presented to an expansion of the EFSF. The European Central Bank is less likely to object, and not all EU nations would need to approve it. And if the plan worked, Europe would finally have a war-chest large enough to handle either a limited or full default by Greece. The risk of a Greek default transmitting to a bond market attack on Italy and Spain would be significantly reduced, because the EIB would be sitting on the sidelines, prepared to buy all and any Italian or Spanish government bonds that were offered for sale. Its buying would push the price of the bonds back up and the yield on the bonds back down, keeping Italy and Spain's refunding costs under control, and handing the sellers a loss in the process.

There's much to ponder. Whether credit rating agencies would downgrade EU countries in response to the Twist, for one thing. How other EFSF money might flow to Europe's banks to cover write-downs on the value of the banks' sovereign debt holdings, for another. But unlike Greece, Italy and Spain are capable of digging themselves out from under the debt loads they are shouldering. The European Twist that is on the drawing board could buy them the time they need to do so.

By the time I got to here I wanted to start typing yadda, yadda, yadda, yadda, &c., &c.

Am I the only person hearing echoes of another financial nightmare like the one that created the train wreck of 2008, except this time the whole global financial world really IS on the verge of crash and burn city?

Remember our last great adventure into the world of Credit Default Obligations?
Remember how mortgage-backed securities were selling like  cotton candy  hotcakes?
Anyone recall neutron loans? 

Is it any wonder that Roubini is telling everybody to get the hell off the beach and prepare, this time for a double-dip recession at the least, or a protracted period of economic implosion that even the dullest of commentators will have to break down and use the word -- depression?

 ~~~~~~~~~~~~~~~~~~~~~~

(For an interesting exercise, click on the RT string at the Roubini link and check out the variety of accounts following Nouriel. I noticed at least three who had marked this tweet "favorite". But move soon. Stuff like this quickly vanishes into the Twitter rabbit hole.)