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The BoomBustBlog Contagion Model: How We Predicted 9 Months Ago That The UK and Sweden Would Rush To Bail Out Ireland, and Why
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Ireland, like several other EMU states, is in a very difficult
position. It has built up significant amount of debt on top of a
crippled banking system of which it has decided to exchange taxpayer
capital for private losses. Like many other EMU nations, it is
overbanked, hence is literally dwarfed by both its banking system and
the bad assets contained therein (see Erin Gone Broken Bank: The 2nd EMU Nation That Didn’t Need a Bailout Get’s Bailed Out Within Months, Next Up??? November 22nd, 2010).
The ECB, EU, IMF and individual states UK and Sweden (in a bilateral
agreement) have agreed to bailout Ireland and its mired banking system.
It is interesting to note that there are actually individual countries
that have volunteered (out of the goodness of their collective hearts)
to assist Ireland outside the collective (UK and Sweden offer over €9bn in bailout loans). The secret of said generosity is in the charts.
As you can see, the UK has little choice but to come to the aid of
Ireland, for in reality it is simply coming to its own aid. As a matter
of fact, Ireland is so intertwined into the other members of the PIIGS
members that its fall (or their fall) literally ignites the contagion
effect that we warned is literally a foregone conclusion (Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter? and Introducing The BoomBustBlog Sovereign Contagion Model).
The European mainstream media sees this obvious motivation on the part of the UK, as this article from the Financial Times demonstrates.
Unlike the UK, Sweden has little
direct exposure to Ireland’s crippled financial sector but Mr Borg said
it was in the country’s interest to prevent Irish problems spreading to
other parts of the eurozone.
“For a country like Sweden, that is
so open and dependent on Europe, it is impossible to sit on the
sidelines when this kind of risk occurs.”
Mr Borg indicated that Sweden’s
contribution to the Irish rescue would be on a similar scale to its
participation in earlier bail-outs for Latvia and Iceland – implying a
loan of SKr5bn-SKr10bn (€530m-€1.06bn).
Of course, the Swede’s generosity can also be explained by their
exposure to their own banking system and that of other countries which
Ireland would be forced to destablize, which would be roiled by the
activity throughout Europe. If we bring back the original charts from
the post Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe…
As you can see, Sweden is in the bad assets bank camp as well as
Ireland, the UK and Spain. This actually puts them in a rather
precarious predicament, but that predicament may not be apparent on its
surface (outside of outsized NPAs as a percentage of GDP, of course).
This is probably why the European MSM reports such benevolent actions as
the FT did, and I repost just for the effect:
Unlike the UK, Sweden has little
direct exposure to Ireland’s crippled financial sector but Mr Borg said
it was in the country’s interest to prevent Irish problems spreading to
other parts of the eurozone.
“For a country like Sweden, that is
so open and dependent on Europe, it is impossible to sit on the
sidelines when this kind of risk occurs.”
Mr Borg indicated that Sweden’s
contribution to the Irish rescue would be on a similar scale to its
participation in earlier bail-outs for Latvia and Iceland – implying a
loan of SKr5bn-SKr10bn (€530m-€1.06bn).
Well, since it appears that the FT doesn’t subscribe to BoomBustBlog (and they really should), let’s break it down for them, shall we?
The focus is now on the contagion effect of Ireland, specifically
(jumping on a monthly basis from Greece, Portugal, Spain, etc.). We have
performed a lot of work in this area in the beginning of the year.
Let’s borrow from our foreign claims model (
Sovereign Contagion Model – Retail (961.43 kB 2010-05-04 12:32:46) and Sovereign Contagion Model – Pro & Institutional)
in order to see who may be effected from the rush to pull capital out
of extant positions to fill the leveraged NPA holes left by the banks…
Ireland has the largest claims against
the UK as a percentage of the its respective GDP, the largest in the
world. In a rush to raise cash by selling assets, expect some fire
sales in the UK. For those who may be wondering how this may affect the
UK, see our premium subscription report on the UK’s public finances
and prospects (recently updated to include the last round of government
projections): UK Public Finances March 2010 2010-03-29 06:20:38 615.90 Kb.
Of course, this is the reason why the UK rushed to Ireland’s aid. This
intercrossed aid will be prevalent over the next year with different
sets of countries running to each other’s side.
Ireland can also be expected to pull
assets out of the ailing PIIGS group as well, since they are, bar none,
the biggest lender to that group as a percentage of GDP. No wonder
their banks are having problems. This is the main reason why the ECB
has jumped into the fray. Their biggest exposure? Italy! See our premium
analysis of Italy’s public finances and prospects: Italy public finances projection 2010-03-22 10:47:41 588.19 Kb as well as their other major exposures: Spain public finances projections_0330102010-03-31 04:41:22 705.14 Kb and Greece Public Finances Projections 2010-03-15 11:33:27 694.35 Kb.
Of course Spain, Italy and the other
members of the PIIGS group are in no condition to rush to the aid of
Ireland since they are most assuredly anticipating the need of aid being
rushed to them in the near future – all public protestations to the
contrary withstanding…
- Portugal Denies Report on Bailout, Eyes Budget
- Spanish Prime Minister ‘Absolutely’ Rules out Bailout
Of particular interest may be the
prospects of the various banks caught in this interwoven web (premium
subscription material). To date, these analyses have proven to be right
on the money:
- Greek Banking Fundamental Tear Sheet
- Italian Banking Macro-Fundamental
Discussion Note - Spanish Banking Macro Discussion Note
Of course, none of this goes to explain
why Sweden has been so generous with the offer of aid to Ireland. So,
let’s dig in to some of the innards of the BoomBustBlog foreign
contagion model to see how successful it has been in its predictive
powers…
Ireland also has the second highest
claims (as percent of GDP) against the central and eastern European
nations, who happen to be in a full blown depression. The withdrawal of
assets, banking support and credit will exacerbate both Ireland’s
problems and that of these nations – along with those sovereign states
who have large claims into said states. Who is the largest claimant. You
guessed it, SWEDEN! This also explains the Swedish loans to Latvia. The
content from this post and the resultant models was originally
published on (and around) Tuesday, March 30th, 2010 at 11:00 pm. Those who subscribed to BoomBustBlog had plenty of time to prepare.
See The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
to find that Ireland can exacerbate the problems of Austrian, Swedish
and Belgian banks by pulling capital out of the CEE region, and yes,
they are truly in a depression:
Austria, Belgium and Sweden, while apparently healthy
from a cursory perspective, have between one quarter to one half of
their GDPs exposed to central and eastern European countries facing a
full blown Depression!Click to Enlarge…
These exposed countries are surrounded by much larger (GDP-wise and
geo-politically) countries who have severe structural fiscal
deficiencies and excessive debt as a proportion to their GDPs, not to
mention being highly “OVERBANKED” (a term that I have coined).So as to quiet those pundits who feel I am being sensationalist, let’s take this step by step.
Depression (Wikipedia): In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen as part of a normal business cycle.
Considered a rare and extreme form of recession, a depression is characterized by its length, and by abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations. Price deflation, financial crisis and bank failures are also common elements of a depression.
There is no widely agreed definition for a depression, though some have been proposed. In the United States the National Bureau of Economic Research determines contractions and expansions in the business cycle, but does not declare depressions.[1]
Generally, periods labeled depressions are marked by a substantial and
sustained shortfall of the ability to purchase goods relative to the
amount that could be produced using current resources and technology (potential output).[2]
Another proposed definition of depression includes two general rules:
1) a decline in real GDP exceeding 10%, or 2) a recession lasting 2 or
more years.[3][4]Before we go on, let’s graphically what a depression would look like in this modern day and age…
A depression is characterized by its length, and by abnormal increases in unemployment.
Price deflation, financial crisis and bank failures are also common elements of a depression.A depression is characterized by … shrinking output and investment … reduced amounts of trade and commerce.
In order for the CEE region to improve,
it must avoid the shocks associated with financial and economic
contagion from far flung regions such as Ireland. The reality of the
matter is that it may not be that easy. BoomBustBlog premium
subscribers may download the CEE bank exposure analysis to see which
banks we feel have the highest exposure to such an incident, or more
realistically, string of incidents:
Banks exposed to Central and Eastern Europe.
From an empirical perspective, Ireland is
in a prime position to export contagion. Not only does it have the 2nd
highest banking NPAs to GDP ratios in the developed world, it has one
of the highest foreign claim to GDP rations as well. I have already
demonstrated how these foreign claims just happen to be concentrated in
today’s problem areas, but Ireland has spread this exposure far and
wide as well. It is second only to Switzerland (due to Swiss private
banking industry) in claims against developed countries. It is also
second only to the Swiss in its total foreign claims as a % of GDP.
You can see some forced solidarity amongst the brethren.
BoomBustBloggers will not be surprised to hear Denmark, Spain and Italy
pop up in the news in the next quarter or two. Oh yeah, Spain is already
in the news…
|
Current Affairs in the News Friday, November 26, 2010 The Next Debt Crisis May Start in Washington: FDIC’s Bair
Keep in mind that Greece and Ireland both denied any possibility of |
Over the weekend, I will attempt to release the Irish Haircut model for professional and institutional subscribers,
which I can tell you now is looking uglier and uglier. I have warned of
these impending haircuts as Wall Street’s sell side assert that they
are improbable. The reason why the haircuts are likely is because
without them it will be virtually impossible for Ireland to bring its
debt level to below 100% of GDP on a sustainable basis without them.
Yes, the banking situation is actually that bad! It is really all about
the math.
After the Irish haircut release, I will delve deeper into the
contagion effect using our proprietary models, which have worked like a
(not so Irish) charm thus far.
In the meantime, peruse the entire Pan-European Sovereign Debt Crisis history from the BoomBustBlog perspective. Any who have not followed me in the past can learn more about me here: Who is Reggie Middleton and What is BoomBustBlog?
For those who want to see how I have seen Ireland throughout the year…
Monday, November 22nd, 2010
If the World Knew What BoomBustBlogger’s Know, Would Ireland Default Today?
Wednesday, November 17th, 2010
As We Have Clearly Anticipated Since Early 2010, Ireland is About to Go
Monday, November 15th, 2010
Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?
Friday, October 15th, 2010
Thursday, October 7th, 2010
Many Are Still Underestimating the Damage That Can Be Done By Ireland’s Bank Troubles
Wednesday, September 8th, 2010
Friday, August 27th, 2010
Tuesday, July 27th, 2010
Friday, July 23rd, 2010
Monday, July 19th, 2010
Introducing the Not So Stylish Portuguese Haircut Analysis
Wednesday, June 2nd, 2010
With the Euro Disintegrating, You Can Calculate Your Haircuts Here
Monday, May 17th, 2010
BoomBustBlog Irish Research Becomes Reality
Wednesday, May 12th, 2010
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Your analysis seems to focus on Europe but what about the debt to GDP ratio of the US. I read someplaces this is not an issue but find that hard to believe when the US hasn't paid back a bean of its borrowings since at least 1971.
As usual, you are all over this. I love how you nailed Swedens ulterior motive. Central Europe is the gasoline all over the floor.
Lithuania, Estonia, Latvia...news blackout.....excepting for 'blond news'...there is SO MUCH political/economic news, real and relevant...so much 'intelligence traffic', so much 'chatter'....seems something BIG BIG is being presciently, from the 'overdetermined' future not yet happened, somehow 'quantum tunneling back'....just amazing....your reminder, thank you, needed to raise the volume HERE above the signal/noise floor...
http://boombustblog.com/images/stories/macro/sovereign_collapse_study/cee/cee_risk_map.isk_map.png
Impressive work Reggie.
Given all the political risks and unpredictability, its amazing to me that the simple math (not that it isn't deep, well-thought, thorough research, but it does appear to be simply numbers) has predicted everything so well. I guess following the money really does say it all.
Thanks so much for this Reggie, I don't trade but it really helps me understand the world. All most Americans see is Europe collapsing because they were PIIGS, not knowing a thing about the banks and who owes to whom.
Besides which country is the next domino, which of course, is what you are focused, I wonder how all this ends in a few years. Any general thoughts?
The math has been fairly simple thus far. From this point on, it will get more complicated as geopolitical and socioeconomic forces move to the forefront. At the end of the day, it is still common sense driven analysis - albeit common sense is in uncommon supply these days.
I have a pretty strong idea of what will happen next, and I will let it out in drips and drabs since it is the focus of my subscription content for the next few weeks.
understood, I will get around to subscribing this weekend, hadn't bothered as I have very little money to play with, but just as sheer news, and protection of the little I have, your content appears well worth it.