European Alphabet Soup for the Layman

Do CMBS, CMO, CDO, ABS, CDS, CLO, RMBS, CBO, TARP, HARP and HAMP sound familiar? As if we hadn’t been subjected to enough abbreviations during the US financial crisis, along comes Europe with their own slew of abbreviations and acronyms. Just as an intimate knowledge of these three and four-letter words were necessary to truly understanding the American crisis, the same is true for the European set. This is therefore meant to serve as a layman’s guide for the various abbreviations and acronyms now at the center of the European crisis.

From the ECB website, the term LTRO (Long-Term Refinance Operations) refers to “A regular open market operation executed by the Eurosystem in the form of a reverse transaction.” Effectively these are loans from the ECB to euro zone banks at low interest rates. They allow the banks to borrow cheaply so that they’ll (hopefully) invest some of the proceeds in peripheral debt, bringing down interest rates for countries like Spain and Italy.

The SMP (Securities Market Program) is officially “Interventions… in the euro area to ensure depth and liquidity in those segments that are dysfunctional.” In essence this program is similar to Quantitative Easing in the US. That is, a purchase of government bonds by the central bank. However, whereas the aim of the program in the US is to reduce interest rates to encourage risk-taking, this program is meant to lower funding costs for peripheral nations such as Spain and Italy. The SMP is also “sterilized” which means the extra liquidity is soaked up elsewhere in the system, so as not to spark any inflation. The program has currently been deactivated, although it may be reintroduced in the near future.

The EFSF (European Financial Stabilization Facility) is described by the ECB as “A [LLC]… for the purpose of providing loans to euro area countries in financial difficulties.” It is essentially a temporary fund, created by the member countries, with the purpose of making emergency loans to member nations in need of them. The fund was used to bailout Greece, Ireland, Portugal and now Spanish banks.

The EFSM (European Financial Stabilization Mechanism) is defined as “An EU facility… that allows the Commission to raise up to 60 billion euros… for lending to EU Member States experiencing… exceptional circumstances beyond their control.” It is similar in function to the EFSF, but is funded by the European Commission instead of directly by member countries, and is smaller in size.

Finally, the ESM (European Stability Mechanism) has been proposed as “a stability mechanism to be activated if indispensable to safeguard the stability of the euro as a whole.” It is “proposed” because it has yet to be officially ratified, but will presumably take the place of the temporary EFSF and ESFM. Its purpose will be to support euro-countries in distress by purchasing their bonds at auctions through the primary market.

Whereas many of the acronyms associated with the US crisis were in fact securitized trading products, all of those described above are actions taken by the ECB in an attempt to stem their crisis. Hopefully these seem a bit more clear now to some of you as I certainly found them to be as confusing if not more so than the first batch.