I am waiting for a definitive statement from Europe before analyzing the new and improved “rescue” plan, but one thing we keep hearing is how the EFSF is going to be leveraged up. The primary problem here is that leveraging up the EFSF involves the equivalent of leveraging up the currency users. Because there is no central treasury the already indebted currency users are the ones bailing themselves out. This is like having 10 mortally wounded gunshot victims rushed into the ER and using the 9 to transfuse new blood into the 1 victim on his/her deathbed. And when you realize he/she can’t be saved you use the 8 to help the 1. So on and so forth until you recognize that what the victims need is an outside blood transfusion.
The result of our ER mishap is a worsening overall credit situation for the Eurozone as a whole. And the credit ratings agencies aren’t oblivious to this reality. Bloomberg’s chart of the day shows us the deterioration (via Martin at Macronomics):
“The CHART OF THE DAY shows the average rating for the bloc, calculated by Bloomberg from the assessments of the three main evaluators, has worsened to 3.14, representing the third-best grade, from 2.12 in May 2010 when the European Financial Stability Facility was designed. The measure fell 0.23 point in the previous 15 months. The average is calculated by giving a numerical grade for each grading, where 1 is the highest, and adjusting it for each country’s share of the EFSF guarantee.
Seven of the 17 euro-sharing nations have had their ratings downgraded since the announcement of the facility, which maintains a top grade from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. As the contagion has spread to banks, prompting governments to work out recapitalization plans, further cuts, mainly for the top-rated countries, may reduce the strength of the fund.”
Leveraging up the EFSF doesn’t resolve our issue. It only spreads the love until the “love” inevitably kills us all. Let’s hope Europe has a real fix up their sleeve and not another kick of the can.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.