US to EU – Drop Dead?

It would appear that we are just a few hours away from some form of Irish bailout. Portugal is a sideshow, but in worse shape than Ireland. So two fixes are due by Friday. While not a total surprise this is happening at lightening speed. I want to make an obvious but very important point:

The Market did this and will do it again.

A week ago spreads on Irish debt got pushed to levels where a bailout is required. On paper they do not need a bailout this week. They have minimal borrowing requirements and technically could just ride out the storm. But Irish yields could not stay at 9% for long. It just adds to the cost of the next guy in line. The next up in the domino chain is Spain, behind that is (incredibly) Italy and should those tiles fall even France becomes suspect.

That chain of events simply can’t be allowed to happen. I will make a prediction: Should Italy fall prey to the markets in a similar fashion as Ireland the dominoes will be falling on every continent.

Italy does not deserve a loss of confidence, but that is irrelevant. Once money starts moving it is very hard to stop. I think every finance minister is aware of this. But I see a big speed bump in the process ahead. That bump is the USA.

When Greece went tapioca last May the EU responded with a $145B (equivalent) support package. Of that, $40 came from the IMF. The US is 17% of the IMF but because there are dirt bags like Venezuela who don’t pony up their share the US is on the hook for ~20% of the Greek deal. Back in May this was sort of a ho-hummer. Some minor opposition:

"It is simply unfair—as a matter of principle—to force American taxpayers to use their hard-earned money to prop up failed policies in relatively wealthy nations," Rep. Todd Tiahrt, a Kansas Republican.

A lot has changed since last May. The opposition to US involvement will not be muted in November. Geithner and Obama are well aware of that fact.

The talk is for a EUR ~100b deal for Ireland. Throw in Portugal and you get EUR 120b or a total deal not so far from that for Greece (total=$160b). The US share of the deal could come as high as $15b if the IMF plays a similar role as in Greece.

This is a rounding error and should not be considered. But it will. The IMF involvement in an Ireland/Portugal bailout will not go over so well with the Tea Party set. But I fear it will get much worse. I think there is a case for the Fed to get involved at some point. They may be forced to open up swap lines to EU Central Banks as part of a broader restructuring of EU debt. Consider this info from the CIA on total external debt.

Note that Ireland has a mountain of external debt that is not Public Sector debt. This is largely the domestic banks. There are cross border assets on the books of these banks. Therefore on a net basis the external debt is not as large as it appears. However in order to address the Irish problem this mountain of assets has to be reshuffled. That will prove to be far more difficult than a narrow bailout of the Irish government bond market. For it to be accomplished in an orderly fashion it will require that large amounts of liquidity be made available. In the past that has always brought the US Fed into the picture.

If a US role is required it will come at a great cost to the Administration. If the Fed gets involved there will be hell to pay. If the USA balks at a critical moment, the EU effort will fail in the market eyes. At that point the market will go into full predator mode. A lot is riding on what should not be such a big deal. But that is the way of things.