Wednesday, November 30, 2011

Compulsory exercise

Eurozone finance ministers’ agreement on the leverage options for the EFSF did
not bring any surprises. The work is not over, yet.

Eurozone finance minister did what they had to do. Yesterday evening, finance ministers approved the next installment of the Greek bailout loan (8bn euro). Without that money, Greece would have run out of cash before Christmas. Moreover, ministers agreed on the two leverage options for the EFSF. The exact size of the leverage remains unclear. As EFSF chairman Klaus Regling said yesterday evening, it will depend on the interest of foreign investors.

Two options will be available to achieve the leverage. 1) A credit enhancement to primary sovereign bonds issued by Eurozone countries. This is the so-called sovereign insurance mechanism in which 20 to 30% of a potential loss could be guaranteed by the EFSF. 2) The creation of Co-Investment Funds (CIF) to purchase bonds in the primary and/or secondary market. There would be three separate "tranches" of this CIF: the EFSF would contribute to the private investors could invest in a "participating" tranche, and the IMF could provide funding for the last tranche.

The weaknesses of these two options are well-known. The success of the EFSF leverage
is highly dependent on investors’ appetite. Moreover, only the CIF option could eventually take countries off the market. With the latest increases in government bond yields for most Eurozone countries, even a successful leverage could be too little to calm markets.

With yesterday’s decisions, Eurozone finance ministers did what they had to do. Nothing more and nothing less. They framed out the leverage option as decided at the October summit. However, with yesterday’s decisions, discussions on further ECB involvement have not been hushed. The search for a credible and loaded bazooka will

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