The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries

Rising fiscal deficits and pending bond maturities due in
2010 are paving the way for the next wave of the Pan-European
Sovereign Debt Crisis - Supply, potentially in excess of demand, which
portends higher yields and more onerous debt servicing at a time of
record fiscal spending!

Please read the following
in sequence if you have not already done so for the requisite
background to this post:

1.        Can China Control the "Side-Effects" of
its Stimulus-Led Growth? Let's Look at the Facts - Explains the
potential fallout of the excessive fiscal stimulus in China

2.       
The Coming Pan-European Sovereign Debt
Crisis - introduces the crisis and identified it as a pan-European
problem, not a localized one.

3.        What Country is Next in the Coming
Pan-European Sovereign Debt Crisis? - illustrates the potential for
the domino effect

4.        The Pan-European Sovereign Debt Crisis:
If I Were to Short Any Country, What Country Would That Be.. -
attempts to illustrate the highly interdependent weaknesses in Europe's
sovereign nations can effect even the perceived "stronger" nations.

Expected higher fiscal deficit and bond maturities due in
2010 have increased the need for bond auction financing for all major
European economies.

Amongst all major European economies, France
and Italy have the highest roll over debt due for 2010 of €281,585
million and €243,586 million, respectively.

 

While
Germany and France are expected to have the highest fiscal deficit of
€125.1 billion and €96.0 billion, respectively in absolute
amount for 2010 (this is without taking into consideration any possible
bailout of Greece and/or the PIIGS, which will be a very difficult
political feat given the current fiscal circumstances), Ireland
and Spain are expected to have the highest fiscal deficit as percentage
of GDP of 12% and 11%, respectively.

 

Overall, in
terms of total financing needed for 2010 (which includes 2010 bond
maturities, short-term roll over debt and fiscal deficit), France and
Germany top the list with € 377.5 billion and €341.6 billion,
respectively while the total finance needed as percentage of
GDP is expected to be highest for Belgium and Ireland at 26.3% and
22.4%, respectively.

However, the
recent spate of bond auction failures across Europe is forcing
governments to increase premiums on new bond auctions (higher yields),
which in turn is resulting in a decline in existing bond prices.

As this phenomenon
continues, the requirement to garner the required funds to finance
scheduled debt repayments and ballooning fiscal deficit will force
interest rate increases (due to market forces) by the central
government agencies in these countries - a situation which will be
unwelcomed in the current situation due to perceived multi-faced
negative  consequences. This while, on the one hand, will
impact banks with exposure to government bonds, will also have the
impact of draining liquidity (excess funds) out of the economy - a
factor which has been instrumental in driving the current rally in
global securities markets since the March of last year - rally that we
feel has flown in the face of both the fundamentals and the global
macroeconomic outlook. A rise in interest rates (other things
remaining constant) is an unwelcome phenomenon for banks as interest
rate spread (difference between interest rate earned and interest rate
expended) narrows.

• According to a recent economist story
  "The bigger concern, however, is not banks' direct exposure to
  government bonds, which average just 5% of euro-zone banks' assets, but
  the impact on their financing. The costs of funding for banks on
  Europe's periphery are rising in tandem with the allegedly "risk-free"
  benchmark rates on the bonds of troubled European governments. [The
  same risk is in store for US banks.] Steep downgrades of the
  sovereign-debt ratings of countries such as Portugal, Greece and
  Ireland would probably translate into immediate rating cuts for their
  banks, as well as higher capital charges on banks' debt holdings and
  bigger haircuts when using this debt as collateral. Regulators are busy
  designing rules forcing banks to hold more government bonds on the
  assumption that they are the most liquid assets in a crisis. That
  premise may not hold for every country's debt." The current PIIGS
  scenario will put this theory to the test, most likely within one to
  two fiscal quarters.

The impact of even a small change in a
bank's borrowing costs can be extreme. According to JPMorgan, an
increase of just 0.2 percentage points in the borrowing costs of
British banks such as Lloyds Banking Group and Royal Bank of Scotland
would trim their earnings by 8-11% next year, assuming they could not
immediately pass these costs on to customers (an increasingly unlikely
event). 

Overall and contrary to many optimistic reports,
the prospects of sovereign default across ALL major European countries
are fearsome and they are also quite real, particularly in France,
Greece and Italy which have a significantly high share of debt and
fiscal deficit as a percentage of GDP, and thus need to raise high
levels of debt to meet their total finance need in an environment that
will reflexively raise their borrowing costs whenever they attempt to
hit the market. As it is, we have had several major European bond
failures to date, and the heavy borrowing is just getting started.

PIIGS - A troublesome area

Greek
banks are most exposed to the fallout as they hold about €39 billion of
government debt, roughly equivalent to the amount of capital they
have. Further, there are rumours that Greek banks have also been keen
sellers of credit-default swaps on sovereign Greek debt, in effect
doubling up on their exposure to a debt crisis. This is telling, as one
or the most important Greek banks is a publicly traded entity that
sports almost 90x adjusted leverage. This leverage supports assets that
total nearly 30% of Greece's GDP. This country's institutions appear to
be literally resting on splintery stilts! It is recommended that
subscribers download the following for a list of Greek banks that we
found to have material exposure: Greek
Banking Fundamental Tear Shee 2010-02-17 02:57:39
420.93 Kb

Moreover, a fallout in Greece is expected to
have an adverse impact across European banks as about 60% of the Greek
government bonds issued over the past few years were sold to non-Greek
European buyers (half of whom may have been banks) according to
Commerzbank, The extent of this impact is not known (at least by me) at
this time, and may be limited in absolute scope, but may spark a
domino effect in relative terms.

  Aside from Greece,
fallout from other troubled sovereigns that make up the acronym PIIGS
(Portugal, Ireland, Italy, Greece, Spain) is also a concern for the
whole of European banking sector. According to the BIS, European banks
have $253 billion at stake in Greece and $2.1 trillion with the other
troubled sovereigns. Further, banks in Germany and France have a
combined exposure of $119 billion to Greece and $909 billion to the
other four members that make up PIIGS.

We should not forget the
US banks which have less exposure to the troubled euro-zone countries
in relative terms, but material exposure nonetheless. According to
Barclays Capital the ten biggest American banks have total exposure of
$176 billion to Ireland, Portugal, Spain and Greece. 

I believe
that Greece's borrowing costs will spike significantly, whether they
receive a bailout or not. Basically, their credibility has been shot.
Reference the following news stories:

Greece Rejects Bailout
Speculation as EU Officials Arrive

Jan. 6
(Bloomberg) -- Greece rejected speculation that it will need a bailout
to tackle the European Union's biggest budget deficit as officials fly
in fromBrussels to scrutinize tax and
spending plans.

"We don't expect to be bailed out by anybody as, I
think, is perfectly clear we're doing what needs to be done to bring
the deficit down and control the public debt," Finance Minister George Papaconstantinou said
in an interview with Bloomberg Television today.

Papaconstantinou Says Greece
Wants to Repair Credibility: Video ... but then appears to
be contradicted...

Greek PM says EU took too long to show
support February 12, 2010 | Source: The
Associated Press Greek Prime Minister George Papandreou on
Friday criticized the European Union as "timid" and too slow to
express unified support for his country during its financial crisis, a
day after Greece won backing - but no detailed bailout plan - at an EU
summit 

EU summit to get to grips with Greece
rescue plans February 11, 2010 | Source: Reuters
EU Discusses Aid for Greece But No
Decision Imminent February 10, 2010 | Source: Reuters:
Euro area finance officials said bilateral aid by
individual EU members, chiefly Germany and France, or guarantees for
Greek debt issues appeared the most likely solution but they cautioned
that no decision was imminent 

EU officials wrangle over possible
Greece rescue February 10, 2010 | Source: The
Associated Press European Union governments are wrestling over how to
help Greece, whose debt crisis has shaken the EU and undermined the
shared euro currency. 

Papandreou Says First Deficit
Is Greece's Credibility Gap Jan. ...

Jan. 28 (Bloomberg) -- Greece's first "deficit" is its credibility gap, Prime Minister George Papandreou said today at a panel event at the World Economic Forum in Davos, Switzerland. Greek Markets Rattled as EU Says Deficit Forecasts ‘Unreliable ... Jan. 12 (Bloomberg) -- Greek stocks and bonds tumbled after the European Commission said "severe irregularities" in the nation's statistical data leave the accuracy of the European Union's largest budget deficit in doubt.

Goldman Sachs, Greece Didn't Disclose
Swap, Leaving Bond Buyers `Fooled':

Feb. 17
(Bloomberg) -- Goldman Sachs Group Inc.
managed $15 billion of bond sales for Greece after arranging a
currency swap that allowed the government to hide the extent of its
deficit.

No mention was made of the swap in sales documents for
the securities in at least six of the 10 sales the bank arranged for
Greece since the transaction, according to a review of the prospectuses
by Bloomberg. The New York-based firm helped Greece raise $1 billion
of off-balance-sheet funding in 2002 through the swap, which European
Union regulators said they knew nothing about until recent days.

Failing
to disclose the swap may have allowed Goldman, a co-lead manager on
many of the sales, other underwriters and Greece to get a better price
for the securities, said Bill Blain, co-head of fixed income at Matrix
Corporate Capital LLP, a London-based broker and fund manager.

"The
price of bonds should reflect the reality of Greece's finances," Blain
said. "If a bank was selling them to investors on the basis of
publicly available information, and they were aware that information was
incorrect, then investors have been fooled."

... The yield on
Greek 10-year government bonds jumped to as much as 7.2 percent on Jan.
28 amid the worst crisis in the euro's 11-year history. Thepremium, or spread,
investors demand to hold Greek 10-year notes instead of German bunds,
Europe's benchmark government securities, widened yesterday by 18 basis
points to 323 basis points.

The spread reached 396
basis points last month, the most since the year before the euro's
debut in 1999, compared with an average of 57 basis points in the past
decade. A basis point is 0.01 percentage point.

"When people
start to fear that the numbers aren't accurate, they fear the worst,"
said Simon Johnson, a former International Monetary Fund chief
economist who is now a professor at the Massachusetts Institute of
Technology's Sloan School of Management in Cambridge, Massachusetts.

... The swap enabled Greece to improve its budget and deficit and
meet a target needed to remain within the region's single currency.
Knowledge of their existence may have changed investors' perception of
the risk associated with Greece, and the price they may have been
willing to pay for the country's securities.

... European Union
officials said this week they only recently became aware of the
transaction with Goldman. The swaps don't necessarily break EU rules,
European Commission spokesman Amadeu Altafaj told
reporters in Brussels on Feb. 15.

The transaction with Goldman
consisted of a cross-currency swap of about $10 billion of debt issued
by Greece in dollars and yen, according to Christoforos Sardelis, head
of Greece's Public Debt Management Agency at the time.

That was
swapped into euros using a historical exchange rate, a mechanism that
implied a reduction in debt and generated about $1 billion in an
up-front payment from Goldman to Greece, Sardelis said. He declined to
give specifics on how the swap affected the country's deficit or debt.

European politicians such as Luxembourg Treasury Minister Jean-Claude Juncker this
week criticized Goldman Sachs for arranging the Greek swap and are
pressing the firm and Greece for more disclosure. Chancellor Angela Merkel's
Christian Democrats aim to push for new rules that will force
euro-region nations and banks to disclose bond swaps that have an
impact on public finances, financial affairs spokesman Michael Meister said.

"Investment banks are guilty of being part of a wider collusion that
fudged the numbers to make the euro look like a working currency
union," said Matrix's Blain. "The bottom line is foreign exchange and
bond investors bought something sellers knew not to be the case."

Comments

[THE DORK OF CORK]

As I have said before on this site - Ireland can pay its sovereign debt no problem but very large amounts of money is being sucked out of the economy to service bankbonds and is destroying any demand in the country , if this crazy situation continues for another year or two there will be no more blood left to drain from Hibernia and Europe will be left with a corpse on its western shores

A amputation of private debt is the only option if the patient is to survive but unfortunately there are no qualified doctors left in Ireland who are willing to undertake radical surgery and our faith rests in the hands of the leach doctors of London and Frankfurt

[Anonymous]

Thank you for the great article Reggie. This brings to mind what Taleb and others have said about a gigantic bubble in sovereign debt. If it starts to unwind quickly I wonder how much control governments will be able to exert to slow it down.

[Don Smith]

I just can't take solace in the truth anymore.  I have lost all faith that the markets will correct.  It seems too much as though the powers that be are just going to find ways to tuck debt away and manufacture money to keep the system churning.  There is no Mad Max scenario imminent.  Riots in the streets of Greece will be assuaged by their government using some accounting trick or another, and it will just get wiped clean by the EMU.  Meanwhile, stateside, DC will just keep doling out the pork and nothing will happen. 

The politicos saw what kind of turmoil a drop like 08/09 can bring, so they'll continue to put a floor in the "market."  People will continue to buy treasuries.  If not China, then the EU. If not the EU then pension funds. If not pension funds, then the Fed.  And if the Fed, they'll just monetize it anyway. 

The floor should have dropped out on treasuries but it hasn't. And it won't. The SEC doesn't care about stock market manipulation and no one seems to care about bond market manipulation.  Maybe the electronic age just makes it too easy to conceal, create, monetize, obfuscate, and destroy wealth such that the markets can't find true value.  Because if they did, there'd be hell to pay.  And DC knows it.  So that won't happen.  I wish it would. But I fear it won't.

[Anonymous]

The swaps themselves may been legal under EU acounting / financial rules, but was the lack of disclosure of this obviously material event in subsequent bond sales a breach of the rules?

[Anonymous]

The figures of Belgium are slightly distorted because Belgium had to bail out 3 major banks in 2008/2009. The financing was done with short term loans (a very sensible decision at that point in time). This year these loans are rolled over into higher maturities. The risk associated with those loans (most notably the Fortis Bank loan) has decreased substantially since last year and the costs are more than likely going to be lower than the associated yield + risk.

I do not mean to say that the bailed out banks are out of the woods, but the whole puzzle certainly looks different than it did 12 months ago.

[Trader_Kos]

But there will be a spillover. 

“WORLD BANK ARISTOCRACY'S FED "DEBT SYSTEM" IS COLLAPSING BUT IT CAN BE CURED WITH BOLD ACTION!

Easy way to remove "DEBT" is to remove the FED's and other Central Banks' DEBT SYSTEMS and place the functions under government control.
The fed is destroying america!

Issue a "CREDIT" currency spent into the system and backed by the FULL FAITH of the US Government to payoff the DEBTS with NO INTEREST CREDIT CURRENCY!
Lincoln did it in 1860's and it worked to avoid the massive financing of the Civil War!
We could stop the DEBT SPIRAL that benefits only the FINANCIAL ARISTOCRACY with one law:
1. Remove the FED and put functions under Government Accounting Office
2. Issue a Credit Currency and pay off the Banks with 0% money!

That easy! But Bankers K1LL for that!”

[Anonymous]

THIS is what makes me proud to be a Belgium citizen...

and oh yeah, our chocolat and beer is also very good...

[DMA Trader]

I can't wait to see on Media the USD DEFICIT problem. 

The US National DEBT wich is 50 times more than all GREECE GDP in 2009. 

ALL this europe debt is such a big joke. 

It's so funny all the media hype this days. 

So the big players can close their longs on USD and get net short.

How is Dubai doing btw. 

[Anonymous]

You forget that Greece only has 5m employed people.

[DMA Trader]

Keep on rollin' 

http://www.usdebtclock.org/

[Reggie Middleton]

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[Anonymous]

great series reggie....where is the safety net?