Let’s not sugarcoat tonight’s “resolution” – this is merely a temporary measure that will buy them more time to resolve the true cause of the currency crisis.  Let’s take a brief look at some of the key points of tonight’s statement (read it in full here):

“All Member States of the euro area are fully determined to continue their policy of fiscal consolidation and structural reforms. A particular effort will be required of those Member States who are experiencing tensions in sovereign debt markets.”

Translation: Austerity will continue.  This is more of the same.  Trade deficit nations undergoing a balance sheet recession will be forced into further budget consolidation which will continue to put downward pressure on growth and ultimately worsen the fiscal picture.  

“We commend Italy’s commitment to achieve a balanced budget by 2013 and a structural budget surplus in 2014, bringing about a reduction in gross government debt to 113% of GDP in 2014, as well as the foreseen introduction of a balanced budget rule in the constitution by mid 2012.”

Translation: they still believe Italy and the other periphery trade deficit nations can undergo austerity, external sector outflows and debt improvements. Greece has already proven this wrong.

“We reiterate our determination to continue providing support to all countries under programmes until they have regained market access, provided they fully implement those programmes.”

Translation: The ECB will temporarily enter markets in order to avoid catastrophe, but will not become the fiscal issuer required to resolve the crisis.

“To this end we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors. The Euro zone Member States would contribute to the PSI package up to 30 bn euro. On that basis, the official sector stands ready to provide additional programme financing of up to 100 bn euro until 2014, including the required recapitalisation of Greek banks.”

Translation: Greece is the offering to the German austerity Gods. Bondholders will take a haircut on the $120B Greek debt they own, but will also be recapitalized. This is really nothing more than a peace offering to those who want to see the banks “take a loss”.

“Being part of a monetary union has far reaching implications and implies a much closer coordination and surveillance to ensure stability and sustainability of the whole area. The current crisis shows the need to address this much more effectively. Therefore, while strengthening our crisis tools within the euro area, we will make further progress in integrating economic and fiscal policies by reinforcing coordination, surveillance and discipline. We will develop the necessary policies to support the functioning of the single currency area.”

Translation: We know we need a fiscal union of some sort, but we can’t get everyone on board. This is a work in progress.

“The EFSF will have the flexibility to use these two options simultaneously, deploying them depending on the specific objective pursued and on market circumstances. The leverage effect of each option will vary, depending on their specific features and market conditions, but could be up to four or five.”

Translation: A larger EFSF will help to stem the bleeding and reduces the odds of a worst case scenario where we experience a Lehman type event. The leveraging of the EFSF ensures that Europe’s banks will not be allowed to fail and cause massive private sector contagion.

“Financing of capital increase: Banks should first use private sources of capital, including through restructuring and conversion of debt to equity instruments. Banks should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained. If necessary, national governments should provide support , and if this support is not available, recapitalisation should be funded via a loan from the EFSF in the case of Eurozone countries.”

Translation: Substantial capital has been set aside in the case of widespread bank failures or recapitalization needs. Again, this fends off the worst case scenario where a massive banking crisis spreads into the private sector.

Conclusion: This is a step in the right direction. By recapitalizing banks and enlarging the EFSF they have set a nice sized rifle on the table. Unfortunately, this is just more of the same in greater size. Ultimately, none of these measures will resolve the true cause of the crisis which is rooted in the currency and the incomplete currency union. Until Europe resolves the imbalance caused by the single currency there is no reason to believe this crisis has ended. I still believe the ultimate resolution here will involve fiscal transfers of some sort directly to the sovereigns that resolves the lack of sovereignty issue. That likely means e-bonds or a central Treasury at some point. We are clearly not there though this statement buys them time.

For now, we can breathe a sigh of relief knowing that we aren’t on the verge of Lehman 2.0. Unfortunately, we can’t expect this to resolve the sovereign debt crisis as austerity will continue and the current measures do not attack the lack of sovereignty issue. All in all, this removes the worst case scenario, but virtually guarantees a muddle through scenario. If budgets worsen on the periphery we should expect to revisit this issue in the coming quarters and the crisis will once again ripple through the market forcing Euro leaders into greater action.  Perhaps a true resolution is not far in the future.  Unfortunately, it likely means more market volatility before leaders realize the true gravity of this situation.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:

  • Anonymous

    Everyone should balance their budget and run a trade surplus. Let me know how that works out.

    “…by reinforcing coordination, surveillance and discipline.”

    That is just freaking me out.

  • Frenchy

    Starting now is the interesting part tho, knowing that this kick in the can will buy some time, will European politicians actually work on greater fiscal union or will they just leave that rifle on the table and go fishing. That is something to focus on and follow over the next quarters.

  • Brick

    So thats a 50% haircut on Greek bonds, but only on privately held bonds which some banks were arm twisted to hold in the first place and excludes the bonds held by the ECB which probably equates to more than half the bonds. It will not be a credit event because european banks have been bribed with re-capitalisation, and banks in the US, Asia and elsewhere will get their palms greased somehow.
    Greek debt is still unsustainable and the euro area will throw 100 billion to keep Greece afloat because it is locked out of the market. That 100 billion either has no funding or does not get taken into account of the EFSF fire power.
    Recapitalisation is based on EBA stressed test which have been weakened to include hybrid capital, an allowance for UK debt being utterly safe, an assumption that the euro area will not have a recession and will grow, being able to ignore counterparty risks and a downgrade of the measurement from Basel III to closer to Basel II measurements.
    Their might be some sort of insurance on sovereign debt for new issuance by the EFSF which would cause a two tier debt system with all existing debt being valued far less than new issuance and causing further problems for banks. This all assumes that the EFSF which is not fully funded can sell its bonds to investors with them knowing the losses the EFSF will most likely take.

    I agree with the conclusions presented here that the final resolution probably involves ebonds and a central treasury, but actually I don’t think they have bought as much time as they think. There will be a rally on the back of the banks rallying, but once that is over and the numbers are worked through I don’t think it solves much. I would give it a month of can kicking ability at the most. Key variables for me would be PMI data in France as banks pull the credit rug from the economy in an attempt to build capital before the deadline next year.

    I would however point out that some economies in Europe do need to sort out some of their taxation issues and entitlement issues longer term because it has become a barrier to aid from the rest of europe. Never completing the building of a house so that it always has half finished bits to avoid tax, covering your swimming pool with Green tarp to avoid tax, being allowed to retire in your 40s because you have a stressfull job like being a secretary (well maybe not but you get the idea). Now is not the time to sort these things out, but commiting to sort them out at some fixed future date, even if it is a gradual adjustment might not be a bad idea.

  • GreedsGood

    Any thoughts on whether the “voluntary” haircut of 50% will trigger the CDS?
    – and if not, whether this may spiral out in some unpredictable fashion given loss of confidence in debt insurance against other sovereigns (namely the next in line for market focus – Portugal, Ireland, Spain, Italy)

    I’m feeling rather naive as I expected the market to sell the news since the actual “plan” was rather weak versus what had been suggested as needed and possibly forthcoming over the past weeks. Even more, I could swear that all the “details” – $1T EFSF, 50% Greek haircut – were leaked by CNBC during yesterday’s session. Yet equity futures move up another near 2% on the official plan.

    Feeling as though I just stumbled down the rabbit hole – anyone else losing confidence fast in this game? Are EU Politicians and associates exempt from insider trading laws the same as ours in the US? Politically connected seems like an awfully good (if not the only) position to be trading from these days.

  • wit

    no credit event…assume u bought greek 10yr bond in 2005…in 2010 u hedged it on cds mkt… u get haircut on yr bond and still have to pay insurance…….what u do with yr other country packages?

  • GreedsGood

    Just dredged up some pertinent stats from a recent article via Kyle Bass:

    “According to the DTCC, there is only $5.7 billion net notional CDS outstanding on sovereign obligations of the Hellenic Republic, versus
    approximately $489 billion of total sovereign debt outstanding (as of September 30, 2010). Net CDS on Greek sovereign debt is equal to 1.2% of debt outstanding”

    It seems that letting the CDS trigger would be a non-event- why the big aversion?

    “The Greek government’s revenue is a monstrous 40% of GDP (only 15% in the US) and Greece has raised their VAT tax to 23% from just 17% this past summer. We don’t think they can possibly burden their tax‐paying population much more even though the prevalent thought in Greece is that they need to tax the populace more to make up for those who pay no tax.”

    Does a debt reduction of $100B as slated today (down to $250B outstanding) versus a $230B GDP which is in peril really give Greece the “clean slate” to move forward? It would seem that without the fresh start, Greek borrowing will remain high-risk/high-yield and the interest burden alone – without the ability to raise tax revenues – will put Greece back in the spotlight within a couple years at most. Perhaps at that juncture with the other peripherals facing similar stresses, the EU will have to wield their only legitimate bazooka (fiscal unification).

    Still scratching my head on the equity market reaction- what gives?

  • Martin

    Brick, that pretty much sums it up nicely.

    So, banks will not only reduce their loan books, triggering in effect a credit crunch in the process, courtesy of banks recap without equity dilution at the expense of the real economy and at the same time, shrink their trading books in the process, to shore up capital by reducing their Risk Weighting Asset base, and as we move towards year end, with window dressing, P and L to protect (for the ones who are still up…) and liquidity dwindling, shedding risk, without adding. You have the recipe for a nice explosive cocktail, so you’ll get wider bid-offer spreads in the process in conjunction with smaller liquidity due to reduced risk appetite.

    And by the way DVA works both ways so, you beef up your banking results with spreads widening, but, hey, guess what happens with serious spread tightening? I call it the boomerang effect.



  • Mercator

    The transition from capitalism to socialism has it odd moments. This is one of them. Historically, it is a very predictable process, so the best strategy is to go with it. It’s too big to get in front of, during our short lives.

  • Malmo

    Without some sort of fiscal union this will all go down in flames. Austerity writ large is obviously self defeating. The assumption that a fiscal union will eventually come out of this is just naive. If anything it’s going to get much worse from here. OWS is about to go global in a big way.

  • jt26

    “Financing of capital increase: Banks should …, including through restructuring and conversion of debt to equity instruments.”

    Will the govs actually force this or are they just saying it to sound like they’ll play hardball?
    Wouldn’t the banks have to enter bankruptcy/administration?

  • http://pragmaticcapitalism Michael Schofield

    With one mighty kick the can has been propelled blocks down the road, far out of the reach of the hungry bears. Does Europe have the resolve to use this paid for time to truly commit to an effective union or will they continue to play this pointless and costly game into insolvency? I can not know the answer, and it’s relevance over the next few months is doubtful, so I must put my bearishness aside. With the tailwind of Q3 GDP the bulls will crush anyone in their path (for a while at least). Like a possum on the road. Like a bug on a dance floor. A man named Quint Tatro once said “embrace the tape”. I will, Quint, I will. This great rally will certainly prevail until it doesn’t.

  • boatman

    a voluntary deal should not trigger CDS’s.

    but will the banks actually do this…..probly but maybe not

  • boatman

    they will not have a fiscal union in my lifetime…..socially unacceptable at this point in time.

    they have just kicked the can up a CLIFF… falls instead of rolls back down.

    ultimately they will rewrite the MAASTRICHT treaty to allow the ECB to print the euro.

    as every country in the world does/will do…..this ends in world currency crisis.

  • Anon

    I’m confused how this leveraging is actually a change from what they had already laid out if the ECB doesn’t step in and no further outside capital comes in. It seems like pure semantics to me to say that the EFSF covers the first 25% of losses, therefore can “insure” over 1T Euro of bonds vs. having 400B Euro of capital. The reality is that the EFSF can cover losses to 400B Euro – that has never changed. So capital shortfalls in banks combined with haircuts to sovereign debt can be covered for up to 400B in total. Is that enough?

  • Alex

    The only significant measure that came out from this meeting is the systemic ease of inter-banking liquidity issues in Europe. All the rest is can kicking. However, this alone, does not remove the tail risk. Tail risk is to have Italy in same position as Greece in not a too distant future. All the current stabilisation mechanisms will be insufficient to deal with this risk.

  • Walk The Talk

    Now that they got the banking thing kind of sorted out, they need to focus on production of goods, the north cannot be the shop floor for the south anymore, the work needs to be spread around. Good luck with that one.

  • ME100

    The conclusion is 3 fold

    1. They kicked the can
    2. Failed to solve the problem
    3. More uncertainty going forward

    = the definition of insanity
    = the rationale for the market surge is corruption
    = Alan Greenspan has told the truth in his analysis the ultimate end is known
    = the timing is, again, uncertain

  • Wynn

    I would trust Hussman on this one, and factor in a 100 billion bailout of the banks withing a short period of time. Deutsche Bank is leveraged at a 33/1 ratio, and invested 240 million in greek debt. That matched with the fact that we are coming up with a less than stellar ISM report in the near future does not bode well.

  • Pierce Inverarity

    How is this a move to socialism? A move toward further banker oligopoly, maybe.

  • Richard Lamb

    I have watched and studied this financial/political boon doggle for years. No where do I read that the insolvent Soveirgns will get financially well from profits/surplus. The first therapeutic issue is austerity. So, we are going to get these guy’s well by starving them?
    The immorality of borrowing has come to roost. The only cure is writing AWAY the massive debt. Go back to ancient times where a new ruler would cancel all debts! Good idea? Actually, major default is the only solution!!

  • John

    Why are the credit markets not joining in with the equity markets on this news?

    All the 10y sov’s have not really moved, italy is down 0.5% on it’s 10yr yeild. Libor and Ted are slightly up and cds’s on most sovs in question are not moving.

    Will this kick be shorter than hoped for…thoughts?

  • http://Yahoo William Oberlander

    Wonder how the people in Greece will cope if they have to report more that 10% of their income for taxes? or declare the family swimming pool for taxation? Does this mean that Europe can not take off work for the summer anymore? I see German bond yields went higher this am, I guess Germany will lower themselves with the rest of the PIIGS.

  • Anonymous

    Being half Irish/half Spanish, I am offended by the PIIGS acronym. But I will accept it as long as we can refer to the “others” as FANG. Deal everyone?

  • VII

    somebody go to beowulfs home and wake his ass up….we need answers.

    Equities are a claim on future cash flows..not on policy makers plan to buy time to fend off a catastrophe. Don’t get it twisted…

    Prepare now for the next leg down. Don’t be frustrated with the move up. Recognize what it is not what your emotions are telling you,”I’ve missed the rally..I’ve missed the rally…I, buy BUY BUY.. this things going to 1440..I just Know it”. Sentiment is increasing..and 2% gap ups have been followed on average by negative returns since 1990. 2008 I think really affects this data negatively..but the volaitlity in 2011 is similar(not identical).

    Our target is 1250 with a max of 1300. ETFs and HFT have changed the metrics to view. One can not just look at mutual fund flows and volume with HFTS commanding 80% of the trading activity is the driving force.

    Retail and Tech look to underperform going forward. These are short term moves…nothing has changed. Remember this the market on average this year should do 22%. So unless the market goes to 1533 and we have the highest sentiment ever recorded….the stock almanac should be used for one thing from 2000-2016. That’s for a 16 year old boy to hide his porn from his mom while he’s on the toilet.

    The bear is not dead…he’s just shaking his head at the stupidity of man.

  • Alan

    “I would give it a month of can kicking ability at the most.”

    Any oddsmakers here? What’s the over/under on when Portugal and Ireland start agitating for their turn? Or will the markets do it for them?

  • chris

    well played brick.

    i give the eu 2 months, and then we will see how the deteriorating economy plays with the banks’ balance sheets.

    as for the efsf, it is hard to see how effective the insurance element of the program will be if it adopts default definitions similar to the isda definitions. all you need is for the ecb not to participate in a restructuring for the insurance to become illusory.

    this makes the leveraged spiv element more critical. makes for a difficult conversation with the chinese, who seem to be having their own financing concerns.

    the wild card in all of this is the ecb. it can go off on its own and start buying sovereign bonds even after the efsf starts up. germany doesn’t want this, and merkel specifically told her parliament that this wont happen, but how can germany stop it? while it would help the situation short term, it would be a very risky maneuver longer term, and it might be the straw that breaks germany’s desire to remain in the eu.

  • chris

    there will be no cds trigger. the isda definition requires that the restructuring be binding on all investors, and the ecb and imf are not participating.

  • chris

    “ultimately they will rewrite the MAASTRICHT treaty to allow the ECB to print the euro.”

    if they do, you can count on germany having boogied out of the eu by then…

  • Gordie

    Richard Lamb:

    Debt forgiveness is espoused by David Graeber, the man behind the OWS movement. He wrote the book “Debt: the First Five Thousand Years”

  • zmt63

    My take is that, I think the positive reaction is much like the post US stress test in 2009, the worst case tail event (at least in the short- to intermediate-term) has been taken off the table. Even if the worst case was a relatively small probability, the severity was really, really ugly. With that removed for all intents and purposes, the remaining probability distribution of the payoffs, especially with the banks, has shifted dramatically in a positive sense.

  • The Dork of Cork

    No I disagree – even in Greece the majority of the money creation was private credit.
    No need for any more central institutions.
    All commercial banking deposits could have been turned into Goverment money and their booked hyperinflated “asset” prices should have been allowed to burn.
    Problem solved.
    Credit banks have been shown to be net negative to wealth generation in the west -so therefore why do we need them ?
    Its because they own us.

  • Mateo

    I’m sorry but I’m unclear on what you mean by the market should do 22% this year…

  • Anonymous

    It’s staged, but the punch line is well worth it:

    (Probably NSFW)

  • boatman
  • boatman

    yes, by all means, forgive their debt….that ought to teach them not to move like molassass and retire at 50, like they have been.

  • JR


  • jswede

    very good point. I agree bonds are not buying it: Portuguese, Irish, Spanish and Italian 10yr bonds improved all of 28, 9, 15, and 3 basis points, respectively.

  • boatman
  • boatman

    he said ‘this is an odd moment’ that means this isn’t socialist.

    but it enables it, if only for the short run.

    and i agree with him.

    thank god(whoever u want to call him/her) i won’t live long enough to have to depend on my ration of SOYLENT GREEN from the socialist, bereaved of all my individualism, independence and entrepreneurial spirit.

  • boatman

    that would have been my thought until i got a primer from a german friend of mine, who was a vice president of IBM, on current german politics.

  • boatman

    bbbb-b-b-but…JR…..what about all the ‘change’ we’re gonna get?

    wait,…..i know……..4 years wasn’t enough.

    how did i know that?

  • JWG

    Today’s jump in US equities was probably the result of short covering. Friday and Monday will tell the tale.

    The ECB’s balance sheet is the key to stabilizing European sovereign debt markets, no matter what the EU does to gimmick and leverage the EFSF. The EFSF is the fiscal contribution that the ECB demanded; once it is in place the ECB will then quietly do what it takes via monetary policy to avoid uncontrolled defaults and cascading counterparty failures during the slow motion crisis. The slow motion crisis will persist intentionally because the minute the crisis atmosphere ends the Greeks and Italians will be back to business as usual and all reform efforts will end.

    One prediction: the ECB will take a 50% (or greater) haircut on Greek debt it holds once the situation settles down and the world’s attention turns elsewhere. Keystroke Euros will fill the gap on the ECB’s balance sheet, and in the future will finance whatever interventional debt purchases are necessary to keep Italy and Spain’s sovereign debt markets afloat. Those two are too big to fail.

    Ireland has a viable first world economy, and the Germans think Portugal has a future as a gateway to West Africa and Brazil. The Germans believe that Greece was THE problem. Does the bond market believe that Greece was THE problem? If not, Portugal will be next.

  • http://pragmaticcapitalism Michael Schofield

    I dumped everything early today- quick 3% gain. Longs, calls, puts, except for a few spy 120 puts. I’ll wait for a pullback to sell. Taking quick profits has been the key to success for me since April or so. Short term- people kept piling in all day be careful on those shorts. Undisciplined traders will be eaten alive. Bearish long term but I would say that would be at least a few months out. I don’t think this market can just turn around it’s too strong and the uptrend is too well established. It will have to go through a technical breakdown process that will take at least a few weeks IMO. Be careful here don’t get sucked in just because the market’s running away. If for whatever reason you’ve been sitting it out you now have to have the discipline to resist getting in late. Sometimes trades run away- accept it. Happens all the time.

  • Octavio Richetta

    Great translation but you are being far too polite in the last two paragraphs. This feels, looks, and smells like what it is: a big pyle of horsh*t. If there is any truth to the efficient market hypothesis, markets should resume downfall soon…

  • Nils

    You don’t get a haircut on your bond. It’s voluntary. So if you’re not a bank you are ok (although the question is how you would have gotten access to CDS if you are not a large player).

  • Nils

    Deal. Let’s move on then.

  • boatman

    futures evaporating and italian bond yield going up.

  • LRM

    Do you think it is possible for individual investors to get ahead in these markets? I am simply on the sidelines and do not have the expertese in trading to do puts, calls etc. As Cullen has said, buy and hold is out in this Central Bank/ Gov interference environment.
    Where does one go to learn some new skills to manage a family portfolio when the traditional holding of a diversified portfolio is not working?
    When you are out of the market to avoid a surprise from a policy mistake you end up missing out on the best month since 1987 . After missing you feel a bit of a fool and desire to make up for the miss and as Cullen said up thread, get your face smashed.
    Can someone give guidance to a reputable source on trading or should assets just be turned over to others with experience ( was it not long ago that record numbers of hedge funds were reported to be having bad year)
    Fustration rant sorry!!!

  • http://yahoo DanielK

    The EU will be hard pressed to solve things the next time when Greece again can not meet their debt payments or….. either Greece or Italy can not roll over bonds coming due because after a 50% haircut, other investors including banks are not interested in another possible haircut. Thus about 9 months to a year and the EU will again be in the same pickle barrel. Would you buy new Greek or Italian bonds or even EU bonds at this point?

  • Sargam

    Hair-cut agreement should be a credit event b/c it’s basically binding on private bond holders. ECB & IMF can do what they want – make the rules, break them, whatever. They are supra-national entities (SNEs). But it won’t count as a credit event b/c most of the private holders would prefer – along with gvmnts & the SNEs – to have negotiated an orderly (and non-market) settlement.