It’s all about leverage in the eurozone

Things seem, for once, to be moving quickly in the eurozone. It's all about leverage in the eurozoneAfter high drama in Slovakia over ratification of the enlarged bail-out fund last week, this week looks set to be all about leverage.

More specifically, it will be about how the eurozone makes sure the EFSF has enough fire power to assure the markets that if things begin to unravel, Spain and Italy will be able secure funding without leaving the cupboard bare.

The plan gaining most traction was proposed by Allianz and involves the EFSF guaranteeing the first wave of losses on Greek, Portuguese and Irish bonds.

This would see the funds boosted to around €3 trillion.

Sounds good in theory doesn’t it? Except the structure looks eerily similar to the instruments at the heart of the sub-prime meltdown – collateralised debt obligations or CDO’s for short.

The CDO’s were supposed to spread risk around the system making it safer overall.

What they did, along with industrial scale securitisation was disconnect the borrower from the lender, mask the risks behind complex mathematical formulas and in turn removed all due diligence procedures about the credit worthiness of the borrower.

The risk with the EFSF insuring debt is that if we move back into a serious recession and other eurozone countries look to default because it is suddenly easier to do so, all the losses will simply have been moved from lots of smaller place to one huge pot.

Despite the worries over the structure of the newly enlarged bail-out funds, euro sentiment continues to improve and lift the Euro against both the Dollar and Sterling.

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