I was bearish before; I’m even more bearish now. European sovereigns are evidencing a lack of confidence in their own bailout plan and the Lehman moment is fast approaching. Have to be crazy to have much, if any exposure, to this market. We will hit new lows. How’s that for dire?
Building the bailout fund is incredibly similar to building a book on an IPO or secondary, something I have done hundreds of times. I can tell a bad deal from a mile away. This deal is bad. With a hot deal, everyone wants in regardless of their fundamental view. Funds will even play in an “okay” deal if they are confident the syndicate bid will support the selling pressure. Sometimes, a fund is even willing to take a small hit in the interest of maintaining a good dialogue with the Lead Managers. But no one willingly goes into any deal if they expect to lose substantial funds. Insiders – in this case, the EU countries with the most to lose if the deal falls apart - often add to their holdings on the offering, justifying it as a capital infusion or a necessary sacrifice.
If the UK were convinced the current plan to stave off European default would solve the crisis and substantial principal wasn’t at risk, they would gladly contribute rather than being labeled the “bad guy” by sitting out the deal. The UK, however, recognizes that this transaction will break syndicate bid before the shares are delivered and that they have to keep their powder dry for when contagion hits their shores in a much bigger way. Once it becomes clear to a book running manager that the deal is being given the cold shoulder by the conventional buyer, they then approach others, such as sovereign wealth funds. In this case, that would be China but they have said no as well.
Coming up 50 billion short on a 200 billion euro book is a huge miss. Unlike a lot of IPOs and secondaries, the EU bailout can’t be downsized to get it to the market in an effective manner. And by the way, a lot of downsized deals often fail because the market regards them as troubled.
Ultimately, the markets shun the underwriters with poor performance by getting their borrows lined up even before pricing. Given the track record of the EU and IMF, the UK and US have already decided the ESFS is a short.
Disclosure: I am long EUO.