In the News This 29th Day of June, 2010: A Whole Bunch of “This Ain’t No Surprises” from Europe

Reggie Middleton's picture

From Europe
Double-Dip May Bring Correction: Roubini

Economic woes in Europe could spread
to the U.S. and lead to a further correction in stock prices, Nouriel
Roubini, chairman of Roubini Global Economics, told CNBC on Monday.

Hey, but wasn’t I saying that since January of this year??!! Remember
back February when the media and the sell side analysts said the Greek
problems were soon to be solved and this definitely was not a “European”
problem but rather a localized one?

BoomBustBlog, February 7, 2010: The
Coming Pan-European Sovereign Debt Crisis
– introduces the crisis
and identified it as a pan-European problem, not a in localized one.

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


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.


Bloomberg has as a headline today: Stress
Tests on European Banks Must Assess Sovereign Risks, EU Draft Shows
Duhhh! As if we should really ignore the biggest threat to the solvency
of the the European banking system in a so-called “stress test”. What
is this, Geithner “lite”?
Reference  How Greece Killed Its Banks! to see exactly how
much damage those who wish to ignore sovereign risks are trying to hide…

While bank capital rules give a risk
weighting of zero percent for government debt rated AA- or higher, it
jumps to 50 percent for debt graded BBB+ to BBB- on the S&P scale
and 100 percent for BB+ to B-.

“These downgrades are going to cause
people to increase their risk weightings,” Yelvington said.

Well, the answer is…. Insolvency! The
gorging on quickly to be devalued debt was the absolutely last thing
the Greek banks needed as they were suffering from a classic run on the
bank due to deposits being pulled out at a record pace. So assuming
the aforementioned drain on liquidity from a bank run (mitigated in
part or in full by support from the ECB), imagine what happens when a
very significant portion of your bond portfolio performs as follows
(please note that these numbers were drawn before the bond market route
of the 27th)…


The same hypothetical leveraged
positions expressed as a percentage gain or loss…


When I first started writing this
post this morning, the only other bond markets getting hit were
Portugal’s. After the aforementioned downgraded, I would assume we can
expect significantly more activity. As you can, those holding these
bonds on a leveraged basis (basically any bank that holds the bonds)
has gotten literally toasted. We have discovered several entities that
are flushed with sovereign debt and I am turning significantly more
bearish against them. Subscribers, please reference the following:

To date, my work both free and
particularly the subscription work, has shown signifcant returns. I am
quite confident that the thesis behind the Pan-European Sovereign Debt
Crisis research is still quite valid and has a very long run ahead of
it.  Let’s look at one of the main Greek bank shorts that we went
bearish on in January:nbg since research

On that topic, be aware that this sovereign risk, amplified and
leveraged though the Pan-European banking system will quickly turn into
economic contagion. Once we have that, then its time to start discussing
the potential for depressions.

Reference The
Depression is Already Here for Some Members of Europe, and It Just
Might Be Contagious!

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 deflationfinancial 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

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.


… as well as highly volatile relative
currency value fluctuations, mostly devaluations.

A former premier has called for a 30% devaluation and
a sitting minister said in June that there should be a “debate.”
Meanwhile, chief executive of SEB, Sweden’s number two bank, says total
loan losses would ultimately be little different if the Baltics stayed
the course or devalued now – though rapid devaluation might be tougher
to deal with. (Lex/


As I stated above, the austerity measures being implemented, in
combination with the compounded financial contagion levered through the
banking system is bound to translate directly into economic contagion.
See Financial
Contagion vs. Economic Contagion: Does the Market Underestimate the
Effects of the Latter?
Once this happens, the seeds for rolling
recessions and potential depressions will spread rapidly and through
unforeseen paths and channels. We at BoomBustBlog have taken great pains
to anticipate these paths and channels, for we are sure they are going
to arrive. The result of our analytical efforts is culminated in The
BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on
the money for 5 months straight!

The BoomBustBlog Sovereign Contagion

Nearly every MSM analysts roundup
attempts to speculate on who may be next in the contagion. We believe
we can provide the road map, and to date we have been quite accurate.
Most analysis looks at gross claims between countries, which of course
can be very illuminating, but also tends to leave out many salient
points and important risks/exposures.

foreign claims of PIIGS

In order to derive more meaningful
conclusions about the risk emanating from the cross border exposures, it
is essential to closely scrutinize the geographical break down of the
total exposure as well as the level of risk surrounding each component.
We have therefore developed a Sovereign Contagion model which aims to
quantify the amount of risk weighted foreign claims and contingent
exposure for major developed countries including major European
countries, the US, Japan and Asia major.

I.          Summary of the methodology

  • We have followed a bottom-up approach wherein we have first
    identified the countries/regions with high financial risk either owing
    to rising sovereign risk (ballooning government debt and fiscal deficit)
    or structural issues including remnants from the asset bubble
    collapse, declining GDP, rising unemployment, current account deficits,
    etc. For the purpose of our analysis, we have selected PIIGS, CEE,
    Middle East (UAE and Kuwait), China and closely related countries
    (Korea and Malaysia), the US and UK as the trigger points of the
    financial risk dissemination across the analysed developed countries.
  • In order to quantify the financial risk emanating in the selected
    regions (trigger points), we looked into the probability of the risk
    event happening due to three factors – a) government default b) private
    sector default c) social unrest. The probabilities for each factor were
    arrived on the basis of a number of variables determining the relative
    weakness of the country. The aggregate risk event probability for each
    country (trigger point) is the average of the risk event probability
    due to the three factors.
  • Foreign claims of the developed countries against the trigger point
    countries were taken as the relevant exposure. The
    exposures of each developed country were expressed as % of its
    respective GDP in order to build a relative scale for inter-country
  • The risk event probability of the trigger point countries was
    multiplied by the respective exposure of the developed countries to
    arrive at the total risk weighted exposure of each developed country.

Latest Pan-European Sovereign Risk
Non-bank Subscription Research

In Bloomberg’s headlines for this morning: Greeks
Stage National Strike to Protest Overhaul to Pensions, Labor Laws
Stage National Strike to Protest Overhaul to Pensions, Labor Laws.
have discussed this in depth throughout the first quarter. As a matter
of fact, in the first quarter, I penned the inevitability of such, and
two quarters later, the strikes continue…

  1. What
    Country is Next in the Coming Pan-European Sovereign Debt Crisis?

    illustrates the potential for the domino effect. Excerpted below…

      It is nonsensical to assume strikers will institute just “one”
      strike, knowing full well that a single strike will not drive the point
      home. It is beyond wishful thinking. Even if that was the case, all
      the union leaders need to do is read Bloomberg to sharpen their plans.

      And on that not, in the nearly five months later….

      I have harped on this topic in my previous Pan-European
      Soverign Debt Crisis
      post, but let me drive it home again. Greece
      is merely a test drive by traders and those who are truly concerned
      about the debt overhang from the global bailout. Yes, it has the
      highest debt to GDP ratio, but it is closely followed by much larger
      nations with much worse, and much more immediate debt and NPA issues.

      As initially illustrated in my last post on this topic, when
      pondering the sovereign debt status of Italy, Spain and Ireland, keep
      in mind how much of their GDP is bogged down by NPAs in their banking
      systems – and this is what is reported, knowing full well that the
      reporting is at best, lagged in
      terms of non-performing assets…

  2. 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.

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

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Panafrican Funktron Robot's picture

I think a lot of this actually rides on Portugal as far as the extent of the damage.  The counterparty risk on Portuguese debt carries probably the biggest contagion bomb. 

Buck Johnson's picture

Spot on Reggie, spot on.  Also I noticed that Spain and Italy and Ireland are the biggest with Spain and Italy over a trillion and Ireland a few billion under a trillion.  I think these three have been playing smoke and mirrors in order to make it look like that they don't have any problems but only Greece and Portugal have.  Spain's been all over the place acting as if it will be one of the ones to help any country in financial peril.  When in reality it's been making banks in the country merge/buy other banks in the country to move the day of reckoning back a few weeks or months.  Then we have Italy who has literally kepts silent and acting as if they are whistling in a graveyard.  And Ireland has been trying to duck and not comment (and if people think that Ireland can't go down, their economy is in shambles).

Somethings coming this week on Thursday and Friday with the closing of the ECB liquidity window.  Spain was out saying don't do it because they can't borrow from anyplace else.  Also they don't really want to roll over the loans from the ECB because for one it will be at a higher rate of interest (they said very high rate) and two it will show who is in definite trouble and who is not by who's going to the facility.

whiteshadow's picture


say mr. reggie, when do i start???

obewon's picture

@ Reggie: a great job of pulling this stuff together!

I guess the western world excels at several things . . . one is fraud, another is cover-up, and yet another is denial.


Cognitive Dissonance's picture

As I talked about in my series on our collective insanity, we all refuse to talk about the crazy aunt in the attic until we absolutely must. Then we follow that well worn script where everyone runs around acting surprised that the news could be so bad, that it couldn't have been foreseen and now what are we going to do.

I love how the western world bashes the Japanese culture of saving face by not forcing each other to face bad news and actually enabling each other to avoid confronting the bad news. How is the western world any different than the Japanese?

I remember countless stories about Japan's lost decade (going on 2 decades) and all the problems caused by allowing their banks to hide losses and the Japanese Gvt issuing debt on top of debt. I see no difference between what the Japanese did and what the western world is doing now.

Denial isn't just a river is Egypt.

moneymutt's picture

no doubt Japan did some crony crap...but really, how bad has their economy been, the people seem fairly well fed, cities clean...they don't have any Detroits that I know of...and wasn't China's/Korea/Taiwan and India's ascent going to a take a huge chunk out of their economy regardless of the their bad monetary/financial policy, they are tiny Islands after all...

Cognitive Dissonance's picture

I'm talking about America's denial that they/we are doing exactly what they/we said the Japanese did wrong. It seems when America does it, it's OK. Anybody else and it's wrong. Japan is not America. I was talking about denial and debt.

Yardfarmer's picture


"The characteristics of technology will always betray their roots in intellect. What the technologists try to pass off as efficiency, advancement, and the good of mankind is really only the scientific manifestation of our self-estranged intellect, that centuries old neurosis which arose from the conflict between our unavoidably emerging individualism and our fear of it. Intellect's answer to this conflict has been always to have us escape into the assurances of a purely external world. And what better way to do this than through the totally mechanized, depersonalized route of technology?...These insecure, anxiety ridden, power hungry technologists who represent the rest of us are forever seeking new means to carelessly examined ends, always applying them immediately, no matter what shaky human purpose they might have or what they might destroy in the process. IF IT CAN DE DONE IT MUST BE DONE"   J. Herbert Fill 




Cognitive Dissonance's picture

Very nice. Do you have a link or a book title?

jkruffin's picture

What amazes me the most, is that the U.S. is in as bad shape or worse than many of the Euro countries, and our treasuries have not been targeted yet.  It is probably going to take a failed auction to get the attention drawn.  The data does not lie and the U.S. should be downgraded off it's AAA status.  None of the reporting agencies have any balls to cut the US debt though.  Let's hope they grow some.

Sudden Debt's picture

It all depends on general moral. Once people lose hope, the feeling will spread to the banks and you'll see the same thing happening.

1 difference with the US and EU: The US put in hundreds of billions of dollars into the banks and forced them to buy the bonds. In Europe, the banks say: Thank you for the money, AND FUCK YOU! Really, they lend money at 0,25% and they don't want to buy bonds that are only 3% because the return is to low and because of the risk is to high.

There are also very large differences between the EU and US bailouts. In the EU they did the bailouts and the ministers who lost in the last elections are now working for the banks. There where quite a few scandals because of ministers selling themselves to the banks.

Most of the ministers are also member of the boards of most banks even before there was a crisis. It's just medieval!

exportbank's picture

The CDS business is red-hot but what happens when the first (big) counter-party can't pay? Will that be considered a Too-Big-To-Fail moment? We know that the CDS's can't be covered - will that be the swan dive off the cliff?

Mercury's picture

I have similar reservations. It's an OTC, non standardized business but CDS buyers do demand collateral. This is covered somewhat in this recent post and comments section.


GoldBricker's picture

It likely depends on policy decisions that have yet to be made.

As a longtime european resident, my gut feeling is that much will depend on the nationality of the first-to-fail counterparty. If it's a German bank, chances are good for some sort of (short-lived) bailout. If the bank is Spanish, tough break. Everyone else is somewhere in between.

We know the general shape of things to come (off the cliff, hit wall, choose your metaphor), but our 'leaders' can still weave left and right along the highway, even if they can't control the ultimate destination. The way to bet is that sub-optimality will be maximized, that the game will be strung along for as long as possible, with maximum capital theft and wastage in the process.

It is through such poor political decision-making (and in other ways, such as a low birthrate) that we here in Europe demonstrate that we are mal-adapted and unfit to serve as a model for emerging countries or for our own future.

Mercury's picture

Reggie, I know that as the sovereign debt crisis unfolds it will cause many people a lot of pain. But how much fun is it to stand over a map of Europe with a red pen and strategize your way to investment glory?

I mean, how do you decide on the right music to play?

Ah, but war is hell...


moneymutt's picture

Good stuff, I think most people don't realize how exposed western/northern European banks to eastern/southern European collapsing economies.

Funny thing, Latvia did just what western economists told them to do, worked out well for them....and just as with US sub prime housing lending, not just the prey go down, eventually their predator, such as Swedish banks and Sweden, go down with them.

Sudden Debt's picture

Most people don't realize that they shouldn't look the once who are worse off, but should realize that EVERYBODY, without exception is about to run off the cliffs.

America & Europe: Both are down the drain and BOTH will get hammered.

And if one idiot says: Yeah but America of Europe is better off then..., just interupt them and call that person a idiot.

moneymutt's picture

have you seen Reggie's stuff on US banks...saying Europe is messed up is not denying US' mess

Dr. Sandi's picture

There won't be a dry seat in the house when this comes together.