Originally Posted by walkinwood
I want to know more details like the size of the debt, who the investors are, any little know side effects, anything like CDOs hiding in the wings etc.
The fear in the markets currently is due to the obvious fact that nobody actually has the details right now. There's a lot of decent synopses from various sources but the following is a fair recap as Boskin touches on all the problems and solutions in a tight manner: Europe
IMO, the first question to ask is whether the European banks have a liquidity problem or an insolvency problem.
Simple bank balance sheet: A (loans and sovereign bonds) = L (deposits) + E (equity)
1) If the write-down to A - in their bad loans (i.e. PIIGS bonds) - is enough to keep E positive then the EU and ECB have a liquidity problem which is simple enough in theory to fix with various levels of pain for equity and preferred bank owners.
2) If, however, the write-down is big enough to make E immediately negative, then the banks are insolvent and the fix is not so simple. Pain will be broad with equity holders totally wiped out and potential effects perhaps affecting global economies for awhile depending on market fear.
The second question is then to ask, if the banks are in trouble, how should the EU and ECB manage the situation to limit the contagion. Two basic and general theories: 1) Borrow money using it's good credit (i.e. ECB, etc.) to make the banks' write-downs whole. EFSF, like TALF, takes this route. The ECB would be "bailing out" the banks like the US Trsy did but the reality is that the ECB would, like the US Trsy did with TALF, be simply bailing itself out since equity holders would pretty much get a value that's a paltry percentage of the total assets (A).
2) The other route to take is the nuclear Swedish option: The EU and ECB wipes out all equity holders and injects its own cash into the banks as equity stakes. This option is, in economic terms, the most efficient path to take but the Prisoner's Dilemma for the EU and ECB is that the wiping out of equity would potentially create such market panic that the financial system freezes. Unfortunately, if the banking system is indeed insolvent rather than facing a liquidity problem, then the Swedish option is the only solution. Throwing money into an insolvent bank is inherently faulty and doomed to fail as depositors would smartly run on the bank until the the thrown money is wasted and no equity remains.