Heading into another weekend like 2008

Just as we did too many times in 2008, we are about to enter into a weekend where all eyes are on government officials and their attempt to deal with a major financial problem. All the big European guns are in Frankfurt to settle differences and come to an agreement: Draghi, Trichet, Van Rompuy, Barroso, Schaeuble, Baroin, Juncker, Sarkozy, Merkel, and Lagarde. The French want to turn the EFSF into a bank that can tap ECB funding, the Germans don’t. The Germans want a 50%+ cut in the value of Greek bonds, European banks don’t. Some want to create country credit lines, the Germans don’t. European banks want to improve their capital ratios by shrinking, EU officials want them to raise private capital now irrespective of stockholder dilution. What soup is going to be made out of this? As I’ve said before, the Germans will get what they want at the same time France fights to keep its AAA credit rating. Bottom line, since the EFSF can’t be leveraged thru direct loan guarantees because of legal reasons and the Germans don’t want the ECB involved, the parties are coalescing around a plan to have bond issuing countries borrow money from the EFSF that will then be put into escrow and would cover a % of principal in case of default. So yes, Italy for example would borrow even more money to partially backstop the borrowing of more money. It’s another example of taking on more debt to tackle a problem of too much debt but again, it’s all about buying time. Also, having the EFSF buy bonds of countries directly at auction is being discussed. In the mean time, bond yields in Italy and Spain continue higher. In Asia, the Shanghai index closed at the lowest level since Mar ’09 and helped to drag down the entire region on growth concerns. Brazil last night cut interest rates by 25 bps to 11.5% over concerns with slowing growth.

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