Is There Any Merit to Operation Meatball Rumors?

By Abe Raymond
Benzinga Staff Writer

In short, I doubt it.

The ECB and EFSF have decided to use the power of leverage to fund the European-wide bailout. Not only is this a foolish plan, since they are essentially refinancing and transferring the debt to the European Union as a whole, but there is no way that the organizations have been able to find over $1 trillion in debt capital.

Very few investors have the faith to invest significantly in the European continent. Considering the obvious risks associated with the region, the EFSF would be pressed to find a multitude of investors to fund their goals. One of the main problems with this is that they have to resort to financial institutions. The majority of financial institutions already have significant exposure to European debt.

For example, Jefferies, whose stock plummeted last week on fears of significant exposure, has started to wind down its European holdings. Moreover, banks including Societe Generale, BNP Paribas, Deutsche Bank, and Credit Suisse all are based in the Europe and clearly have some of the highest exposures to the region. Similarly, Morgan Stanley stock got hammered over the last few months on similar fears.

Considering the obvious risks involved, these institutions, which are already filled to the brim with exposure, may not be willing to be direct investors. On the flip side, what they may be able to do is act as a liaison between investors and the EFSF. Investment banking platforms already partake in this activity, whether it is for investors in IPOs or debt offerings, or investors for exotic securities and derivatives.

Taking part of the middle-man process could garner lucrative revenues for the investment banks. The only problem is the risk of a conflict of interest, which may be something banks want to avoid. For example, banks typically take the risk up front, and divvy up the securities – debt or equity – to investors after they have already been packaged. The same would probably take place for European debt, and it may not be likely that investment banks want this sort of exposure, considering the lack of frothy, confident markets.

Another thing investors need to be wary about is that the confirmed bailout plan primarily covers Greek problems. The EFSF would have to amplify the leverage to be able to cover Italy’s problems, assuming that its debt issues are similar to Greece’s and not much smaller. This makes the prospect of a solidified Italian bailout all the more uncertain.

The EFSF would have to consider how it would go about covering all the debt. For example, the EFSF may think that using so much leverage to be able to cover everyone is not the best idea. It may think that using an approach similar to the US – taxing its citizens – would be the best way to raise funds for a comprehensive bailout.

Operation Meatball, as some rumors have dubbed it, does not seem very likely. The EFSF will have to find many investors along with more sources for leverage. On the flip side, markets seem to have rallied since the rumors started spreading at 1:15pm. Investors will have to be careful going into Friday, as news may dispel the rumors or may confirm them, meaning that extreme volatility may be in store in the near-term.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.