Amount of European Bailout Fund About Right Finally

Yes, it has been awhile.  Ironically I am even more engrossed in the goings on of the market with my new position at CFA Institute.  But, alas, time has been scarce.  I wanted to highlight for everyone that the Europeans are finally talking (after two years of dragging their feet) about the correct amount of money to fund their bailout.

The most persistent fears, of course, are that Greece will default on one or more of its debt issues.  Greece has about $420 billion of debt outstanding and a debt level that is about 139% of gross domestic product, or GDP.  So any bailout fund, like the European Financial Stability Facility (EFSF) would need to have more than $420 billion.  In fact, what has been pledged up until now is about $600 billion.

But then there are the other members of the PIIGS nations, Portugal, Ireland, Italy and Spain.  Ireland has successfully restructured its bank’s debts and redone its budget to ensure its continued solvency.  Then there is Portugal – a disaster of a financial situation.  But, and this is a big Sir Mix-A-Lot type of but, Portugal’s economy is tiny.  So that leaves Italy and Spain.  Here we are talking about two of the largest economies on the planet.  Not easy to ignore, in other words.

Of the two nations Italy is the nation with the bigger problems.  Its sovereign debt is about 119% of gross domestic product (GDP) and it carries about $1.2 trillion of debt.  So if you add up Greece’s debt and Italy’s debt you get about $1.62 trillion.  And the Europeans are now talking about a $2 trillion facility.  That’s about $380 billion of spare bailout capacity.

The big fear of course is that there is a run on the banks in Europe that creates a cascade of bank failure, monetary sclerosis (money is every economy’s lubricant), and economic catastrophe.  So any bailout has to cover the worst-case scenario.  The world’s investors have finally caught the attention of the European finance authorities and politicians.  Now the question is: will they do anything?

I place the odds at just slightly better than half that there is a resolution.  If not, that doesn’t necessarily equate with disaster – it’s just not the preferred outcome.  The preferred outcome is that nervous investors worldwide can shift their obsessive attention away from “worst-case” scenarios and start focusing on the fact that the very businesses whose shares they are selling in mass numbers are actually doing quite well business-wise.

Separately, and lastly, I have been speaking with several very large equity portfolio managers and they are all chomping at the bit to deploy cash in the cheapest financial markets that they have seen since, well, 2009; and before that, 1973.  But for the fact that their shareholders are liquidating and creating the need for them to sell to cover cash redemptions, they would be buyers of businesses right here.  That’s a very encouraging sign…that is, a possible end to the massive bout of irrationality.

Jason