The Coming Pan-European Soverign Debt Crisis

Reggie Middleton's picture

Banks are the epicenter of the economic crises that face the developed
and emerging nations over the last few years. The fact that governments worldwide have made the (generally unwise)
attempt to bailout their big banks by transferring bad debts and
liabilities from the private sector and bank investors to the public
sector and taxpayers doesn't mean that the problem has been solved or
even ameliorated. As a matter of fact, I believe the problem has now
been amplified, for now we have effective increased the implicit
leverage in the already excessively leveraged banking problems as well
as removed the natural firewalls that may have been in place by having
the problems in individual financial institution versus sitting on
government balance sheets, able to affect all without the need of the
"domino effect" that was feared from the Lehman collapse.

This leverage stems from the fact that most European sovereign nations
are considerably "overbanked". The levered assets of the banks in many
Euro-sovereign nations easily outstrip those nations' GDP's. So when the
nations' banks get in trouble from bad banking practices (and a very
large swath have), the nations themselves not only are helpless in
attempting to truly save the banks (and instead only institute a bait
and switch wherein private default risk/insolvency potential is swapped
for public manifestations of the same), but are put at risk themselves
for the bank is actually more of a sovereign entity than the sovereign
is - at least from an economic footprint perspective. This is what
happened in Iceland. If one were to take an empirical look at other
nations in Europe, Iceland and Greece are merely the tip of the iceberg.
I have warned about this over a year ago regarding Spain and the
Spanish banks (see The
Spanish Inquisition is About to Begin...
), and now the chickens are
coming home to roost.

As it stands now, we have the most developed nations suffering from
indigestion after bailing out their oversized banking industry, with
many of the allegedly balance sheet bailouts actually being illusory and
liquidity-based in nature. The US is case in point here, since most
banks still have untold hundreds of billions of dollars of losses still
sitting on their balance sheets, and the US taxpayer is stuck with the
equivalent of hundreds of billions of dollars in losses simultaneously.
Accounting rules have been laxed to give the impression of record
profits in lieu of what should be record losses.

We also have European countries such as the UK which has nationalized
several of their largest banks, taking on significant losses on the
taxpayer's balance sheet, but still facing the drag of a poorly
performing banking system that is still too big for the economy as a
whole. Just the non-performing assets of just the top banks in the UK
amount to nearly 9% of their GDP! That is a very big chunk of dead money
floating around in the system that literally invalidates X% of reported
GDP. The UK also has nearly $200 billion of exposure to Ireland, whose
bank's NPA's are roughly 6% of that naion's GDP, the second highest in
all of Europe save the UK (who has the same problem)!

The smaller sovereign nations that failed to keep their hands on the
fiscal and budget reigns during the global liquidity bubble are also
facing issues. Greece is the current poster child for this scenario,
having been downgraded by the ratings agencies, money
and capital are fleeing from the country in a typical "run on the bank
their debt being shunned by the markets with CDS
exploding and the
big market makers in their debt refusing accept their bonds as
. This is Lehman Brothers, part deux, which actually makes
plenty of sense since the solution to the banks failing was the
government taking the failing asset risk onto the balance sheets, hence
now the governments are being seen as at risk of failing versus the
backstopped private sector.

The larger sovereign nations are at risk of either having to bailout
their less fortunate brethren or facing the fallout of having the
repercussions of a domino effect reverberate across the EU and its major
markets/counterparties. This goes deeper than some may suspect. For
instance, the weakest sovereigns in the Euro area are still the central
and eastern European nations, and the stronger sovereigns are heavily
leveraged into these countries through their "overbanked" system. If (or
when) these companies start to publicly exhibit cracks, quite possibly
due to the domino effect of Portugal, Greece and Spain finally tipping,
then you will find the Nordics showing stress through their banking
system (the biggest CEE lenders) at a level that the countries may be
hard pressed to backstop, for their banking systems are literally
multiples of their GDPs.

I will attempt to illustrate the "Overbanked" argument and its
ramifications for the mid-tier sovereign nations in detail below and
over a series of additional posts.

Sovereign Risk Alpha: The Banks Are Bigger Than Many of the


This is just a sampling of individual banks whose assets dwarf the GDP
of the nations in which they're domiciled. To make matters even worse,
leverage is rampant in Europe, even after the debacle which we are
trying to get through has shown the risks of such an approach. A sudden
deleveraging can wreak havoc upon these economies. Keep in mind that on
an aggregate basis, these banks are even more of a force to be reckoned
with. I have identified Greek banks with adjusted leverage of nearly 90x
whose assets are nearly 30% of the Greek GDP, and that is without
factoring the inevitable run on the bank that they are probably
experiencing. Throw in the hidden NPAs that I cannot discern from my
desk in NY, and you have a bank that has problems, levered into a
country that has even more problems.


There is a Method to the Madness: On to my perspective of the
individual sovereigns

We performed a pan-European scan to identify banks with rising loan
losses from troubled
exposure. We retrieved an initial list of 510 banks and applied a number
of filters based on a) Banks' assets as % of GDP b) Texas ratio c)
price etc to arrive at 40 banks for deeper analysis.

The selected 40 banks were organized into different sets for analysis
based on the country of domicile.

1)      Spain - Owing to serious issues surrounding Spanish
banks, we analyzed the four Spanish banks separately. It is observed
that Spanish banks are witnessing substantial increase in NPAs. Included
in the list is BBVA
which we have already covered (see The
Inquisition is About to Begin...
, which has turned out to be a most
profitable trade).  Among the four analyzed banks, the weakest bank had
the highest Texas ratio of  51.6% and rapidly growing NPAs (increasing
132.5% over the last one year). Banco Satander , Spain's largest (and
arguably, strongest) bank, is also witnessing substantial
increase in NPAs growing about 95% over the last one year. The Bank's
Texas ratio stands at 37.5%, although low relative to other banks
examined, is still rich and the rising provisions for loan losses are
depressing Bank's profitability. The stock has risen 86% over the last
one year and is currently trading at Price-to-tangible BV of 2.1x. Banco
Satander has an ADR. Subscribers can download a tear sheet on
all Spanish banks investigated here: Spanish Banking Macro Discussion Note Spanish
Banking Macro Discussion Note 2010-02-09 02:48:06 519.40 Kb

I will continue this post with banks and sovereign stress data for
Austria, Belgium, Sweden, Denmark, UK,
Greece and Italy as well as the countries in central and eastern Europe,
Asia and other emerging markets over the next few days. In the
meantime, let's compare Spain and Greece on an apples to apples basis...


Subjective thoughts on the Spanish Situation: Embedded
structural rigidities will prolong the downturn causing the oft sought
after "V shaped recovery" to become an unlikely occurrence. The very
high private sector debt levels most likely exacerbated the effects of
global downturn. A round of consolidation and restructuring seems
inevitable as both the NPAs in its banks are increasing on a fundamental
basis and the banks are forced to come clean with the true losses on
their commercial and residential real estate in the form of increasing
NPAs (see The
is About to Begin...
) as well as the share of NPLs which are also
increasing. PWC expected the bad loans ratio to increase to 8% by the
end of 2009. It is apparent that the sector will need refinancing.
however, Spain's loan-to-deposit ratio of 130% is higher than the
Eurozone average of 115%, which shows Spain's high reliance of wholesale
funding and securitization channels, both of which have dried up. 

What is not publicly touted about Greece? Greek banks
exposure to emerging Europe poses an additional downside risk to the
economy (I will get into this in detail for subscribers later on this
week). Public debt stood at 94% of the GDP with the current account
deficit rising to 14% of the GDP in 2008 (deteriorating public fiances
is another concern).

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Anonymous's picture

The Euro-zone should not be looked at as an isolated case. As others have said, the same excess-leverage applies to numerous other banks in other countries, e.g the US and China.

This isn't a case of the Euro-ship sinking because it was torpedo-ed by more fiscally responsible countries. This is a case of global excess-leverage, where all irresponsible sovereigns sink together...and that includes the US, Japan, Canada and China.

Currency devaluation is relative. If all currencies devalue, there is no net loss, although they must take it in turns...

Anonymous's picture


I have read hundreds if not thousands of reserach reports in the last 20 years, imho, you beat them all.

Impressive all the way.

Thanks for Sharing

Kevekev's picture

Hey Reggie,  off subject but any thoughts on DDR's 37.3 million new share offering?

DaveyJones's picture

excellent, frightening article Reggie, thanks.

Anonymous's picture

The D in STUPID should be Denmark, not Dubai.
We have a bankbailout that includes that if banks fail, EVERY depositor gets bailed out by the danish taxpayer.

(danish citizen here, our politicians are morons)

MarketWizard's picture

Why Greece? Why Now?

New Europe
For the winds to set sail for the troops of the Greek coalition and battle against Troy in the world of Ancient Empires, the Gods wanted the leader of the expedition Agamemnon, to sacrifice his daughter Iphigenia. And, so he did according to the last play by Euripides, written around 408 BC.

Twenty five centuries later, Europe is in deep trouble facing the worst economic crisis ever. Catastrophe is imminent and an Iphigenia is badly needed. The Euro, the common European currency, officially launched on 16 December 1995 was at the time given a life expectancy of 15 years by Milton Friedman. We are now in 2010 and facts prove that Friedman was correct.

Now, Europe needs its scapegoat and this was chosen to be Greece. Not because the Greeks are more corrupt than the Germans or the British neither because Greece has committed any sacrilege. We can give you many examples of British or German corruption cases having occurred with the blessing of the European Commission. Greece is too small to be dishonest by European administration standards. Greece was simply chosen to be, because it has a new government, all honest people acting in good faith with little experience and certainly unaware of how corporate gangs operate in the “civilized” world.

Greece also has a big public deficit accumulated over the last 30 years. Those mainly responsible for the accumulation of this huge deficit are the European Central Bank and the European Commission who allowed the debt to accumulate. The Commission and the ECB were responsible all these years for auditing Greece and all other European economies. The argument that the Greeks were cheating in their statistics all this time is beyond a joke. Indeed, if Greek civil servants at a salary of 800 Euro per month were capable of 30 years of cheating in the face of the auditing “super-brains” of Brussels and Frankfurt who enjoy salaries of 15.000 and 20.000 Euro per month, then Jose Barroso and his colleagues in the College, should turn to something stronger and perhaps more illicit to avoid reality...

In this context, I have to add that the Greek government and the Greek administration claim that Greece is suffering an across-the-board unethical offense by financial speculators. Although it looks to be true, I think that the Greek authorities, in defending their case, have a very limited view of the issue, and therefore are missing the real target of the speculators. That is the European currency itself – The Euro is under fire. The Euro is the target of the speculators where there is real profit.

Why else would two of the world’s leading financial newspapers attack Greece on their front pages every single day?

What is it worth?

No, Greece is not worth that much bad publicity.

The Euro is the target and the target hides political and speculative reasons. The end of the Euro is coming and it is coming soon, as since its introduction, Europe although it had a common currency, did not manage to get a common budget.

Indeed, the common budget would signify the political unification of Europe, foreign and defense policies would have come under, and the combination of a common currency and a common budget, would have brought political unification.

Last but not least, we reprint here above last Friday’s front page of one of the leading financial papers of the world which speaks of the so-called (in Brussels) “the four PIGS” (Portugal, Italy, Greece and Spain). Indeed, what I as a journalist with common sense do not understand is why, among the four PIGS, “Ailing Greece infects market,” when it is the smallest of the four, and from the published table, Greece seems to have the best performance than any the other three.

Anonymous's picture

Lengthy but poor argumentation. And vastly untrue.

The person has an extremely limited understanding of what one is talking about. No need to comment or argue. Which does not mean I support the Euro construction.

Anonymous's picture

He has a point. Why Greece? Because Greece is a safe bet to make easy money for any speculator. It is known that Greece can be bailed out and will be bailed out. Vital piece of information.

The same for California is not possible. Because no one knows if California can be bailed out.

Eternal Student's picture

Amazing. And I haven't seen this information elsewhere.

Thanks once again, Reggie.

One minor typo nit:

"for now we have effective increased the"

Should be:

"for now we have effectively increased the"

Reggie Middleton's picture

There's a lot more to come. I am effectively short much of the developed world. This banking/debt situation is much worse than the media is making it out to be. By using the term "contagion", they are negating the actual cause of the problem which is the inherent acceptance of boom/bust cycle economics by both the public and the private sector - with each boom and bust getting progressively worse and more correlated across national boundaries. The next time around (which is now, with global risk asset markets skyrocketing) will probably be the straw that breaks the debt camel's back. There are no issues that are contagious, the problems facing Greece are already inherent in almost all of the Eurozone, Japan, China, and the UK.

RossInvestor's picture

Reggie, is there a reason why you left the USA off your list?  IMHO it remains the epicenter of the crisis.

Reggie Middleton's picture

I am always harping on the US and this is a Euro post. Although the US is the epicenter, I do believe that we are better off than much of Europe and the big Asian economies, though.

I also want to make it clear that the rally on the Greek bailout rumors are basically traders chasing movement, or fools. A Greek bailout will simply have every other deficit laden company jump to the front of the line. At that point, they are damned if they do or damned if they don't. Then we have the larger countries, ex., the UK et. al.