The primary organism responsible for this socialist backstopping is the European Financial Stability Fund, or EFSF. The EFSF has the authority to issue $440 billion in additional bonds backed by European Area Member States, or EAMS, which means that Greece is lending to Portugal through the EFSF, and Portugal is lending to Greece. The credit rating agencies have (naturally) given this bailout vehicle their highest rating, AAA. Go figure. The system represents nothing more than a European version of a collateralized debt obligation (CDO) or collateralized loan obligation (CLO). You may remember, CDOs and CLOs helped ruin the financial system in 2008. To certain market participants, garbage intermingling with trash with a spice of waste produces a sweet European fragrance.
Seduced by this “sweet” aroma, when a government like Portugal fails and a bailout is imminent, the market perceives it as a non-event at worst and as a positive at best, because CDOs and CLOs allow leverage to be piled upon leverage. When the economy is doing well, the prospect of leverage actually enhances returns. The EFSF offers a Euro version of quantitative easing, providing a tailwind for the market when the market is going up.
The European effort does not actually fix the system, and in true Americano style, it is a form of kicking the can down the road (Americans may not be great at soccer, but we are elite can-kickers). For this reason, the European debt crisis continues unabated, passing from one country to the next. There will be a day of reckoning; the question is the catalyst, of which there are many possibilities. Spain, by itself, could crash the entire fiesta, straining the best laid bailout plans based on pure size. The country I am particularly watching is Ireland. There has been chatter in Ireland about default on some of its bonds, which has the potential to start a chain reaction across Europe. It changes the game theory scenario. Default seems inevitable for many of the EU countries, but it can be pushed off at the expense of citizens for years. If Ireland defaults, Greece and Portugal should very quickly come to the conclusion that they can default also, bringing down the pyramid of leverage and instigating the European version of America circa 2008. Because the euro structure is much worse than the dollar, such a crisis also likely would create a currency panic.
