“No one should take for it for granted that there will be peace and affluence in Europe in the next half century,”

Chancellor Merkel. (HT:CNBC)

Ka-Blam! The Eurozone is saved. They’ve found just the right drug cocktail of financial bailouts. The markets are all a screaming buy!1!1.(/sarcasm off)

If only this were the truth. The reality here is that the Europeans will destroy a bunch of bondholders who financed Greek debt. They will then borrow 1/2 to 3/4 a trillion Euros to prevent this from triggering a bankruptcy cascade. 15 – 35% of this bill will then be sent to the US Treasury and this loss will be socialized by the US tax base.

Step One. The bondholders foolish enough to hold Greek Government Debt Instruments have agreed to take a voluntary 50% haircut on that portion of their portfolio. The scare italics around voluntary is the key. This means Greece doesn’t technically get charged with a “hard” default.

Why would anyone that doesn’t enjoy Feta Cheese and Classical Philosophy really care? If there isn’t technically a hard default, the credit default swaps protecting the purchases of the Greek bonds don’t trigger. The people who sold the CDS insurance just pocketed premiums and won’t have to pay a dime – even though the Greek debt securities have done precisely what the CDS insurance was designed to protect against.

That way, neither the Greeks, nor the institutions insuring their debt securities will get what they deserve. How does the EU intend to fix all the people who would be ruined by letting both the debtors and the insurers off the hook for their prodigal profligacy? The EU will say the magic word “Bailout.”

Step Two. The EU will take the existing EFSF (European Financial Stability Facility) and leverage its assets times two to four. This will allow them to lend on the order of 1 Trillion Euros to Eurozone nations that face economic dire straits. In return for this generosity, Greece, Italy, Portugal, Spain and Ireland will all be expected to tighten the screws on their governmental spending. Greece, in particular will be held to account next June. (No Really! They mean it this time!)

So just how does the Eurozone magically turn 250 to 440 Billion Euros into a Trillion? For starters, they have to improve the capital reserves of their banking system so that people outside of Europe will foolishly trust them. Banks all across Europe have eight months to raise their reserves to 9%. This ambitious project is being undertaken because the EFSF intends to get the additional 560 Billion Euros from a variety of sources. The UK Telegraph describes step three below.

The EFSF will be boosted via both risk insurance and a special vehicle that will buy bonds. “Further resources” would come from “co-operation with the IMF” and sovereign wealth funds, including China. The fund would be tasked with “ensuring financial stability” in the eurozone.

Here’s how I see this working out. Once the Greek bondholders got assigned their voluntary haircuts, the likelihood of anyone savvy buying risk insurance from a European approaches a mathematical limit of 0. The Special Vehicle Bonds will soon be nicknamed FIAAs (Fix it again, Angela!). Nobody with a two-digit IQ would buy a bond described as a Special Vehicle. The UK has told the EU “No.” This leaves China and The IMF.

China typically has a very large current account surplus that they need to plow into something. For the nonce, that something is a large and expanding portfolio of US Treasury Bonds. China is not a bad choice as a White Knight for Europe. However, this will put upward pressure on US Treasury rates. Good luck with Operation Twist, Ben!

Even if we manage to keep China out of this EFSF rescue for our own sakes, the US will still pay a significant share of this European bailout. The IMF (International Monetary Fund) exists to provide support to economic basket-cases such as Zimbabwe, North Korea and much of Southern Europe. Between 15-20% of the IMF bail-out capital comes from the United States. (Exactly 17.72% as of July, 2011)

Assuming 17.72% was all we got Robin-Hooded out of for the profligate Southern Europeans, we would pony up 100 Billion Euros of the 560 Billion Euros the EFSF wants to raise. I’ve made a best-case assumption on that number. As you pop two Excedrin pills, keep these facts handy. Germany is supposed to pony up 6.57% of the IMF cash. France owes 4.52%, Italy 3.32%, the Netherlands and Belgium about 2% each. Take these guys out, since solving problems yourself defeats the purpose of the IMF, and the IMF is short 18.41% of its financial resources.

If we get pessimistic here, the US has to replace that entire swath of prosperity. This would stick the US with about 200 Billion Euros worth of tithing for continued world peace. So, as I pessimistically predicted a while back, Lafayette, Here We Come! (Dagnabit!) So, assuming the completely unworkable Eurozone compromise actually works, the United States will only get the bill for between 100 Billion and 200 Billion of Southern Europe’s binge consumption tab. I can’t imagine why the DJIA went up over 2% to celebrate that!