Markets approved the announcement of a European agreement to address its sovereign debt problem in unison rather than the previous fractured approach, but there was no clear statement on how the EFSF plan will actually work.
The market reaction in the US seemed more geared towards the 3rd quarter GDP report than the sentiment that Greece can actually be saved by the bell.
Many questions remain unanswered and there are more than just a few uncertainties with regards to the funding of the European Financial Stability Facility and the execution of its dual pan.
The EFSF will basically consist of two portions: one will serve as insurance while the larger portion will need extra capital to extend loans to its members in need.
Greece’s outstanding debt was effectively reduced by 50% through a joint European accord.
The result of this new agreement will be that banks will need to be recapitalized in order to adhere to the new 9% tier-1 capital ratio requirement (up from the previous 5%) and it is uncertain whether banks can raise such capital in the private sector.
The consequence will also be that France may lose its much coveted AAA rating in the process, not to mention if Italy and Spain fail on their sovereign debt as well.
Should the Greek situation spill over to both countries, than there may be dire consequences for the guarantors of the EFSF, i.e. Germany and France.
This still leaves the question how the EFSF will obtain its funding for its envisioned 1 trillion euro lending portfolio.
One scenario is to seek a capital injection from China in return for the issuance of structured debt, guaranteed by the EFSF.
This may have long-term financial consequences should Greece default in the future and the Italy and Spain situation does not improve.
The agreement may be a step in the right direction but there are too many variables in the game to put an approval stamp on it right now.
The first thing that needs to happen is to receive approval of the majority of investors for a 50% “haircut” of Greek sovereign debt. Should such not occur than the entire scenario moves from a voluntary debt reduction to a mandatory, meaning default.
That would put Greece and Europe back in the same position as where they started.
The cards have been dealt at the European poker table and both Germany and France went all in.
Only time will tell whether the move was a bluff that pays off over time or whether they bet the whole barn and own the house money in the end.
For now Greece has probably been saved by the bell, but for how long?
Written by Nick Doms © 2011, all rights reserved.