Geithner’s plus-sized euro bailout is stealth QE3

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SEATTLE (MarketWatch) -- Stocks have ripped higher in volatile trading this week as investors grow more comfortable with an emerging political plan to stabilize financial conditions in the euro zone, a plan filched straight from one of the Grimm’s fairy tales, “The Master Thief.”

In the tale, which is duly Germanic, a young man seeking the hand of a nobleman’s daughter is sent by her father on an increasingly audacious set of robberies -- the last one of which, well, I don’t want to ruin it for you. Let’s just say it does not end well for the commoners, who are always fleeced.

The big idea in Washington now seems to be that if Europe can be paid off to pipe down about its banking crisis for just a few weeks, then Wall Street can settle into a good old-fashioned earnings season in October with no distractions. This is sort of like packing your crazy old uncle off to the movies when your guests arrive for a dinner party, but hey, you do what you gotta do.

The plan, cooked up by U.S. Treasury Secretary Tim Geithner, is to persuade European leaders to vastly expand the size of the emergency bailout fund known as the EFSF, or European Financial Stability Facility. His proposal, and I’m not making this up, would use leverage -- i.e., borrowing -- to increase the size of the already borrowed money in the fund by up to 10x. Read more on market expectations for expanded EFSF.

This is a little hard to believe, but it’s the truth. The funds from euro-zone countries in the EFSF have already been borrowed. And now the plan espoused by Geithner is to use that money as collateral to borrow as much as ten times more. The guy does not get enough credit for his evil genius.

Why would they do this? Well dial back your mental time machine to the fall of 2008, if you will. You will recall that before TARP there was a similar U.S. plan to bail out the financial system, but it was judged to be too risky. So now it looks as if Geithner, who was the head of the New York Federal Reserve Bank at the time, is conspiring with the International Monetary Fund and others of like mind to recreate that massive weapon of financial destruction to aim at the debt crisis in Europe.

If you close your eyes and meditate a moment on the concept, you can think of this extra-extra-large EFSF as a stealth quantitative easing platform, or better yet, a super-gigantic stimulus package that, despite its size, would actually be rather stealthy. Smart, huh?

They aren’t calling the EFSF a stimulus ploy, but you see if the money is actually deployed into the European banking system to fill in the cracks where Greek bonds used to be, then it would push money that did not previously exist into the world’s financial veins. The path from there is a little convoluted, but it should then work its way back to the United States as the Europeans buy boxes of Cocoa Puffs and bottles of Clorox, and maybe a Chevy or two.

They won’t say this of course. The cover story is that boosting the size of the EFSF would prevent national parliaments in France, Germany, Finland, Slovenia and other euro-zone countries from having to vote on an increase for the size of the bailout fund.

But the reality is that Geithner, Lagarde & Co. want to circumvent Congress and EU legislators by creating, essentially, a credit derivative hedge fund that would spray super-charged money on an arid European bankscape in hopes that something will grow.

The plan would at minimum recapitalize the region’s banks and provide for a Greek sovereign debt default that could allow for a 50% loss of capital by lenders.

Will it happen? In some ways it will not matter for awhile if it does not or not. Just the idea that it could happen may provide a buzz of hope and confidence. Like kids daydreaming about prom, the anticipation is so much better than the event. Late on Monday the Germans were uttering their usual guttural negative reaction to anything that the Americans propose, but my guess is that they will ultimately go along with it.

Now let me sidestep a moment outside of journalism and into the realm of conjecture for a hidden reason that the Germans and French may be working so hard to save the euro zone and Greece, which on the surface seems like bad bets.

Everyone knows that by backstopping Athens financiers, the government of Chancellor Angela Merkel has said that it is really saving German banks. But I am guessing that additionally the Germans and French do not want bankruptcy examiners to have a chance to sniff around the Greek balance sheets and find out what happened to all the missing billions.

To be sure, it’s possible that Greece simply squandered the money it borrowed. But what if there has been something like a Ponzi scheme afoot the past few years -- a Madoff-by-the-Mediterranean, if you will -- in which Greek government or banking officials have siphoned off the money and secreted it at European banks with the tacit agreement of their creditors?

I have no evidence for this. It is just a hunch based on the logic that sums this large with so little oversight provide overwhelming temptation, and on the fact that it does not make sense that the straight-laced French and Germans are working so hard to preserve the southern bacchanalia.

And there are plenty of obstacles to it getting done. Late Monday, the head of the constitutional court in Germany, Andreas Vosskuhle, blasted the efforts to push the country toward a new debt solution by stating that no fiscal powers may be surrendered to Europe without a new constitution and a popular referendum. The comment was believed to complicate plans to boost the EFSF to 2 trillion euros, as any suggestion that Merkel is conspiring with the EU elite to circumvent the Bundestag is political poison.

According to a report in U.K. newspaper The Telegraph, the top German judge told a Frankfurt newspaper: “There is little leeway left for giving up core powers to the EU. If one wants to go beyond this limit -- which might be politically legitimate and desirable -- then Germany must give itself a new constitution. A referendum would be necessary. This cannot be done without the people.”

In short, the super-sized EFSF is not a done deal. But if it is accomplished, it could be a whopper that would make the fairy tales seem unimaginative, and set the stage for a robust fourth quarter rally.

Of course, piling debt on debt to pay for debt collateralized with debt is inherently unstable, however, so don’t get too comfortable because the bill will come due.