1. Here come the CDS stories. This is the one about US banks selling CDS to European banks, just like AIG did a few years ago. The banks assert that these holdings are hedged, that counterparty risk is less now and better understood, but the market does not appear to be buying this argument.
2. The European Financial Stability Fund (EFSF) is funded by member states with Germany and France together guaranteeing about 50%. Italy and Spain guarantee about 30%. Since the latter two may need bailouts eventually, there is a circular logic to this. Forget the circularity for the moment. The EFSF can issue bonds, make loans to distressed countries, finance recapitalizations and intervene as needed in financial markets. All this is well known as is the fact that they have about 250 billion euros in the pot which will be leveraged up.
I want to bring your attention to the SPV (Special Purpose Vehicle) portion of the recent initiative. How do you get the Chinese and other investors to buy the bonds the EFSF will issue to accomplish its goals? You provide guarantees against first losses (the skin in the game idea). In other words the EFSF will be the equity holder and the Chinese the debt holders in a CDO-type structured finance product. This is bringing out doomsayers in droves. The thinking is: such leveraged structured finance may have brought Enron down in the 1990s. Such leveraged structured finance may have brought down the global banking system in the late 2000s. And now governments are getting into this game?