This is a version of the Swedish solution, whereby shareholders and bondholders take the first hit in any recapitalization before the state injects equity. I have long been an advocate of this approach, but even that proposal needs a re-think. That's because the eurozone problem stems from too much sovereign debt accumulated by a number of EU member states and much of that debt was stuffed into eurozone banks. So the solution of the state rescuing the banks who lent the state too much money becomes a circular problem of trying to insure yourself.
What's more, the spectacle of EU states trying to rescue themselves has become too big. John Hussman put some scale to the size of the problem this week [emphasis added]:
My guess is that European leaders will force a bank recapitalization within days - probably 100 billion euros, preferably 200 billion, but the larger number is doubtful because at present market values, European banks would have to sell new shares in nearly the same quantity as their current outstanding float in order to acquire the new capital. Yet Stratfor correctly notes that even in the event of a 200 billion recapitalization, a 50% haircut on Greek debt "would absorb more than half of that 200 billion euros. A mere 8 percent haircut on Italian debt would absorb the remainder." So a good chunk of the present EFSF could end up recapitalizing banks, especially if too little is raised from private investors. This would leave little ammunition against any further strains, should they develop.The current rumor is that size of the forced bank recapitalization will be about €108 billion, which would be roughly half the value of market float at current prices. Bank CEOs
€2 trillion = 20% of global FX reserves
If those aren't the solutions, then where else could the EU get the money? I wrote on Sunday that Europe has three choices:
- Get more money internally from the strong states within the EU such as Germany;
- Get more money externally, e.g. the US or BRIC countries; or
- The ECB prints the money.
[T]o put the magnitude of Europe’s crisis in context, it would take nearly 20 percent of the worlds accumulated foreign exchange reserves to account for the approximately 2 trillion euros needed to contain the EU debt crisis for a mere 3 years. The unlikelihood of such funds materializing is compounded by the fact that most of the foreign currency reserves are held by low-income countries with little political room to bail out one of the world’s wealthiest economic zones.The kinds of shock-and-awe eurozone rescue figures that have been bandied about have been in the order of €2 trillion, which amounts to roughly 20% of global foreign exchange reserves? China has already signaled its reluctance to step up and help in a meaningful way. How likely are the other emerging market countries come to the rescue?
In short, forcing European banks to drink from the poisoned bank recapitalization chalice today could the policy mistake that plunges Europe and the world into a synchronized global slowdown. Don't expect other players, such as the IMF or emerging market economies to come to the rescue because the scale of the problem is just too big.
I guess it's all up to Super Mario now.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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