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Saturday, October 22, 2011

EFSF - European Financial Stability Facility

Author Thomas Ramseyer 
Creation of trust in the debt service of highly indebted countries
Alternative Insurance Solution to be discussed

Tapping EFSF-funds to buy collateral (considered useless)
The idea is to grant junk economies' governments access to EFSF-credit for the purpose of buying high class bonds to collateralize additional junk government's debt.

Such high class bonds are held by investors all over the world. I.e. fed, national banks, private investors, insurance companies, banks, funds and others. Thus the envisaged task will create unwanted competition for this market segment.

Also a partial insurance in case of default will not have prudent investors buy junk paper. In case of default a lot of problems can be foreseen. The procedures would turn out to be very time consuming.

Such measure taken is considered absurd and useless.

This idea must be discarded before even discussed.

Solution: Invention of european style put options to secure final redemption at par (considered being of value)
Procedure e.g. Greece
a) Issuance of a government bond with a nominal coupon slightly above german level.
b) Provide european style PUT-option to grant final redemption at par. 
c) The PUT-option will be issued by European Financial Stability Facility ( EFSF).
d) Greece has to buy the related PUT-options at a price representing the actual market's  yieldspread at present value.
e)  EFSF grants a credit to Greece as to facilitate the purchase of the aforesaid put options.
f) The options shall be subject to a listed secondary market. Thus investors with more risk appetite can sell part or all of the put-options to people seeking more protection.
g)  EFSF creates further PUT-options on already existing low quality bonds.

The EFSF has an effective lending capacity of hundreds of billions through guarantee commitments from euro area Member States
The aforesaid commitment restores confidence of all marketplayers immediately. The market liquidity of such bonds will upgrade dramatically. Bonds are traded Put-option included, Put-option excluded and on the third line the Put-option itself.
This procedure will give time to countries to recover. The measures taken by the latter and the ongoing partial achievement (milestones) will even enhance liquidity. There will be a vivid market. 

With the Put-option once invented the investors will resume investing in the former low quality bonds which easily can be held as investment grade bonds again. 

The Put-Option-Solution will prevent unnecessary money supply adventures. Governments as well as the ECB will no more be in the unwanted position of holding government bonds. Investors' unnecessarily held cash will be used to buy EU-states bonds of any origin again.

Read, discuss, conclude and tackle