Proposed European Bailout Plan Comes Up Short

Proposed European Bailout Plan Comes Up Short

by Jason Jenkins, Investment U Research
Wednesday, November 30, 2011

The plan to increase the capacity of the Eurozone’s European Financial Stability Facility (EFSF) is in dire straits.

Several Eurozone officials have stated that the now €440 billion rescue fund may only be able to raise in additional funds about half of what Eurozone officials had expected due to the market conditions that have transpired over the past month.

Ace in the Hole

If you want to know what’s caused all the market volatility the last few months, look no further than the Eurozone. The markets have reacted favorably to any words of sensibility and logic coming from officials. And then the markets tank when those promises have not come to pass.

But their ace in the hole was the suggested policy to offer insurance on losses for investors buying troubled Eurozone bonds, which would have leveraged the €250 billion excess capacity of the rescue fund about five times what it is presently to more than €1 trillion.

Leveraging the EFSF’s dwindling resources was the highlight of the grand plan introduced last month at the Eurozone summit. The added capacity would create barriers to stop the Greek contagion from spreading to European banks and the other troubled states in the South. Most importantly, they didn’t want the crisis in Greece to hit the zone’s third-largest economy – Italy.

Borrowing Costs and Bond Yields

In the last few months, Italy has shown the world that it doesn’t need Greece’s help to implode. The massive increase in Italian – and to a good extent Spanish – borrowing costs has brought to light just how bad the problem is right now.

Everyone from U.S. Secretary of Treasury Tim Geithner to China have complained that Eurozone officials needed to stop dragging their feet before it’s too late…

And now, it may be too late.

The dramatic spike in borrowing costs for Italy since the last Eurozone summit is likely to force the EFSF to offer a better deal to potential investors. The sweeter deal you give, the lower number of bonds the insurance would cover.

EFSF Chief Klaus Regling said earlier this month that overcoming investor concerns with improved guarantees would mean the fund was likely to have only three to four times the firepower.

Other officials have said that the target Regling stated may not even be attainable. A more realistic goal may be somewhere in the neighborhood of two to three times the remaining buying capacity of the fund.

On top of this, there’s still a concern that there could be a possible French downgrade, which would dramatically sap the strength of the EFSF because the fund’s foundation is based on guarantees from AAA-rated countries.

What’s the take?

When you have crazy markets and uncertainty with the European Central Bank, there’s no certain way to tell how much EFSF bonds will be worth or what the fund will be able to insure.

The track record of the zone and its proposed policies make it hard to believe that investors will be flocking to these bonds. Things are so bad that they just gave Greece a 50-percent haircut on its debt. That’s not setting a good precedent with future investors. Uncertainty in Europe will translate into uncertainty in the markets for the time being.

Keep your sights set on the long term and those valuations that make sense. We’ve been talking about multi-nationals who have taken advantage of emerging market growth or investing in companies with strong dividends for added returns.

Good investing,

Jason Jenkins

Article by Investment U