Can we fix it? Yes we can!

Europe central bankers have stolen Bob the Builders catchphrase with their latest and greatest proposal to help the struggling european nations.   For those without children, grandchildren or young nieces and nephews - Bob the Builder is a children’s animated cartoon where the main characters catchphrase is “Can we fix it” to this the other characters shout  “yes we can”.  This is a bit like what is happening at the European Central Bank right about now.  

Defaulting on its debt is nothing new for Greece by the way.

According to academic research, Greece was awarded the dubious honour of recording the first ‘default’ back in around 377BC.  Greece has defaulted on its external sovereign debt obligations at least five previous times in the modern era (1826, 1843, 1860, 1894 and 1932). The first episode occurred in the early days of that country's war of independence, and the last default was during the Great Depression in the early 1930s. The combined length of period under which Greece was in default during the modern era totalled 90 years, or approximately 50% of the total period that the country has been independent.

Although many might consider this level of default to be excessive, Greece is nowhere even close to the top of the list. Venezuela and Ecuador, with 10 defaults each, share the (dis)honour of being the greatest serial defaulters of the modern era.

The latest rescue package announcement to hit the wires is for the use of the European Financial Stability Fund (EFSF) which was created by the euro area member states in May 2010 to assist with the debt crisis that was unfolding at that time. 

There are several moving parts in the proposal but essentially it goes like this -  banks would be allowed to exchange their sovereign debt for debt issued by a special purpose vehicle (SPV) created by the European Investment Bank and capitalised with funds from the EFSF.  The creation of the SPV is seen as important to protect the members and ensure that neither the ECB nor EIB are left carry the can should this all turn to custard.

It is important to also understand that prior to this latest announcement the EFSF has already provided emergency funding to Ireland, Portugal and Greece.  The expectation is that a further 100 billion euros in additional funding is needed just for Greece.

Some commentators are speculating that the proposed plan will effectively make the new vehicle a levered fund, which borrows far more than it has in equity capital provided by European governments. After reading this I am left wondering how leveraging the new fund is going to help and wasn’t this kind of how we got into this mess in the first place?  Maybe we never learn from our past mistakes?