RCM CIO casts doubt on ability to expand eurozone bail-out fund

As Berlin votes today on boosting the eurozone’s rescue fund, the European chief investment officer of RCM has cast doubt about the ability of politicians to ‘supersize’ the European Financial Stability Facility from its current €440bn.

Neil Dwane said the EU and Berlin, each already in the process of approving a second Greek package, are “unlikely to want to be bounced into a new mega-EU-peripherals-plus-banks rescue plan before receiving the clear undertaking that all EU governments will be managed properly in the future”.

One plan mooted is to allow the EFSF to leverage itself well beyond its asset size, while another is to use an EU special purpose vehicle, “which can forcibly recapitalise all banks as required, as the US did with TARP in 2008/2009.”

But Dwane then added: “How this is done is unclear at this time. Politics is such a hard issue to call, and sentiment from investors in all markets will be swung by changes to the assessments of them ‘doing the right thing’. Arguably, to date the EU has done just enough only when faced with a financial black event on the horizon.”

Dwane holds, however, that Greece, the first beneficiary of the Luxembourg-domiciled fund, can default and still remain in the euro.

He says there is now “common acceptance” that Greece will default, an option the equities specialist within Allianz Global Investors supported since May 2010.

“Recent IMF estimates suggest that Greek debt to GDP is about 180% and not yet under control, with the economy currently contracting at about 7%. So perhaps a default of 50% to 60% of GDP is mooted, with a clear plan for austerity going forward and a model for other financial perpetrators.”

Dwane said markets were pricing in a 50% chance Greek will default, and the question was now not ‘whether‘, but ‘by how much‘ Greece will default, and who will recapitalise affected banks.

Dwane said banks globally have shown recently „they are, despite much management protestation, still at the heart of the problems troubling the global economy since 2008.

“EU banks, especially the French, have fallen 50% in a month as sovereign stress and super leverage, plus funding concerns, grow and grow. In the EU banks are now at 2008 Lehman-lows, though they still need massive amounts of dilutive rights issues.”

Amid all this, Dwane did give limited good news for willing investors.

“Equities have fallen a lot already, are under-owned in the EU, and offer two or three times the yield of most sovereign bond markets. The world is suffering from excess and excessive debt, such that default and inflation inevitably beckon. Equities are the answer, not the problem, but remain whipsawed by events which are not of most corporates’ making.”

He said when QE3 and EU solutions are put to work by printing money and government borrowings, “investors should remember to protect the real value of their investment, not the monetary value, especially if holding depreciating assets like the US dollar”.


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