Playing The Contagion II: Goldman Recommends Betting On Contagion Risk In Portuguese, Spanish And Italian Banks

Tyler Durden's picture

Earlier we pointed out the surge in CDS on a variety of PIIGS banks, mostly in Portugal and Spain. Now we know why: Goldman's Charles Himmelberg has just reiterrated his call for Long CDS on local banks in Portugal, Spain and Italy, hedged by selling Main (iTraxx) protection. It is our view that as accounts plough into this trade and as bank spreads blow out, it will only accelerate the funding complexities, the bank runs and the inevitable collapse of the financial systems in all of the other imparied peripheral countries, ultimately leading to the collapse of the EMU. Will Goldman be accused next of destroying Europe? Stay tuned.

This morning the Greek Prime Minister called for a financial lifeline of as much as €45bn, provided by the EU and the IMF. Our European economists discussed the mechanics of the package in their April 21, 2010 European Views: “Greece initiates formal negotiations with the IMF/EU – Q&As on the most important issues for the weeks to come”).

With total debt around €265bn, they believe Greece is not out of the woods yet. The Greek government faces a financing gap of about €51bn during the next 12 months, and will need to enact strong fiscal tightening (up to 10% of GDP) and new reforms to re-establish growth.

We continue to think pressures on southern European sovereigns are not a threat to corporate credit markets. The re-financing issues and tight fiscal policy of Greece will not translate into a broader contagion, we think, because Greek firms account for less than 1% of the Euro-zone market (Germany, the UK and France are 60%) (for more details see “Sovereign risk and the contagion to credit”, Credit Line, February 5, 2010) That said, southern European banks will likely struggle. Pressures on sovereigns will likely hit small businesses and the local banks they borrow from. Instead of popular trades like shorting sovereign CDS or the Euro, we recommended buying default protection on the local banks in southern Europe, which at the time traded tighter than the CDS of their respective countries. Following increased sovereign risk, as well as increased competition for deposits, the banks in southern Europe have sold off, underperforming both the broad market, their sovereign CDS and the Euro (Exhibits 9, 10, 11 and 12). As a result, our trade performed well over the past month and is up 142bp today.

High unemployment, decreasing house prices and poor to capital markets are likely to continue to challenge firms in southern Europe, where corporate bonds are only around 7% of GDP (compared to 14% in the rest of Europe and 28% in the US). Local banks, which used to rely on a stable deposit base, will face increased competition from larger players, who are willing to diversify away from bond funding. They will also face new regulatory charges over the coming months. While we remain positive on financials as a whole, we think the local southern European banks will continue to underperform.

For these reasons, we re-iterate our recommendation to buy protection on local banks in Portugal, Spain and Italy against iTraxx Main (Exhibit 13).


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john_connor's picture

OK, I actually agree with Goldman here.

Mercury's picture

Seriously, how many ZH readers who have been paying attention wouldn't put on trades like these?

Reggie Middleton's picture

All they did was cut and paste from the BoomBust - and I started warning this time last year, beginning with Spain and BBVA. I really don't know why everyone swears these guys walk on water.

Actionable Intelligence Note For All Paying Subscibers on European Bank Research As I Explicitly Forwarned, Greece Is Well On Its Way To Default, and Previously Published Numbers Were Waaaayyy Too Optimistic! The Pan-European Sovereign Debt Crisis, to date:
  1. The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a localized one.
  2. What Country is Next in the Coming Pan-European Sovereign Debt Crisis? – illustrates the potential for the domino effect
  3. 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.
  4. The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries
  5. The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
  6. The Beginning of the Endgame is Coming???
  7. I Think It’s Confirmed, Greece Will Be the First Domino to Fall
  8. Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!
  9. Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?
  10. Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire!
  11. Germany Finally Comes Out and Says, “We’re Not Touching Greece” – Well, Sort of…
  12. The Greece and the Greek Banks Get the Word “First” Etched on the Side of Their Domino
  13. As I Warned Earlier, Latvian Government Collapses Exacerbating Financial Crisis
  14. Once You Catch a Few EU Countries “Stretching the Truth”, Why Should You Trust the Rest?
  15. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!
  16. Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe
  17. Moody’s Follows Suit Behind Our Analysis and Downgrades 4 Greek Banks
  18. The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!!
  19. How BoomBustBlog Research Intersects with That of the IMF: Greece in the Spotlight
  20. Grecian News and its Relevance to My Analysis
  21. A Summary and Related Thoughts on the IMF’s “Strategies for Fiscal Consolidation in the Post-Crisis
  22. Euro-Gossip Debunked, Courtesy of Trichet and the IMF!
  23. Greek Soap Opera Update: Back to the Bailout That Was Never Needed?
  24. Many Institutions Believe Ireland To Be A Model of Austerity Implementation But the Facts Beg to Differ!


Kina's picture

I don't suppose they pay for the stuff that they steal.

bugs_'s picture

Could Goldman be right this time?

hungrydweller's picture

Goldman is always right.  Your only decision is to determine whether the Squid will be betting against you in their own recommendation.

buzzsaw99's picture

GS doesn't care how you play it so long as you do play.

Franken Stein's picture

It doesn't matter how you play this. At the end of the day you'll lose and the Squid will win. They are doing gods work after all.

VegasBD's picture

It just curious how long it takes before the greece version of American Idol goes off the air and McDonalds closes. Thats what has to happen here before people really wake up. Ill be watching these countries fail keeping an eye on the timelines to better predict it for us when it begins here.

Mr Lennon Hendrix's picture

The Hollywood Futures Index has just fucked up the money.  I have stocks soaring for two years on the back of the falling currentseas.  Nominal gains mostly; equities will only prosper if they beat inflation.  I think the major Corporations will do best.  Investors have already piled into the likes of HOG et al, and once the emerging middle classes of China and India can afford Harleys etc, well....they love us for our culture, and hate us for our fascism, er, I mean freedom.  Right George?

Also, once baby boomers trade in their Hummers because $7 gas is a bitch, they will tell their wives, 'Haven't I always wanted a Harley?'  Lie to me.....

Hansel's picture

This call will do wonders for Goldman's reputation in Europe.  They are begging for more lawsuits, investigations, etc.

MsCreant's picture

The left tentacles do not know what the right tentacles are up to? Hmm...

FranSix's picture

EUC policy rates are far higher than U.S. discount rate.  As of today, the policy rate is still @~1%, though market rates for short term treasuries are probably much lower.


EU still has room to play on this one on a policy level.  


EU yield curve:

Gordon_Gekko's picture

Its funny how the INSOLVENT US banks are warning of and advising how to "play" contagion/implosion risks in other countries and their banks.

Gordon_Gekko's picture

That sounded like Benny boy just saw Gold shoot up a 100 bucks. How you been MsCreant?

AccreditedEYE's picture

This is the very same group of vipers that was telling us all was well with Europe for the past 2 weeks... I don't trust them as far as I could throw Blankfiend. (and with my bad back, I shouldn't be throwing anybody)

A hundie says these fools are taking the other side of this trade. Such scum bags!!

ghostfaceinvestah's picture

This does me no good.  How would a retail investor make these bets?

AccreditedEYE's picture

He/She doesn't.. these are hedge fund/institutional investments for speculation and/or hedging purposes. Even if you could, would you? Vipers probably issued the order to have their private equity and hedge fund tentacles  to start buying the equity anticipating a major Euro-zone announcement. Makes me sick.

Myshkin's picture

EUO is the only way I know to play this mess (awfully indirect).  Who has better non-derivative suggestion?  Short Euro bank ADR's?  I guess I could short in the foreign markets, but then I'm stuck in Euro's, which I hate...

AccreditedEYE's picture

First, you are assuming the Squid is betting with you by going along with their "advice". Second, and I don't know the Euro equity market well, but, assuming you are taking their advice for what its worth, they are saying smaller banking players will feel the pain. It might be tough finding an ADR for smaller local southern European banks....I've never checked though. :)  And, wouldn't the volatility be vicious in these issues? Easily manipulated? Easily shorted? Plus the carry on the dividend payouts which would suck...I could be wrong.   

Myshkin's picture

Yes, you're probably right.  Thus EUO, which seems like an overly simplified way to try and capitalize on the issue.  My only question is - if Greece actually pulls out of the EU, would that hurt or help the currency?  I think there are enough issues with other member states, but it seems to me quite possible that Greece pulling out would actually help the Euro... which would make EUO an flawed approach...

Amsterdammer's picture

A view from Europe: Step 1 would involve GSI London

through the British FSA lose its bank charter

as first retortion measure.

The squid has been involved in the "hairdressing"

of Greek debt, and supposedly another major

European country; I initially had the idea it was the

UK, now I have the idea it may be France, where

not only is the government's ófficial debt'suspiciously

low, and the big players' banks there massively

underwater, thus I would expect some action

from the EU, which can move pretty quickly

when it comes to banking matters ( another

commissioner ).

Last but not least, today Bosch, not the smallest

German company, has made public it is cutting

all business with GS



trav7777's picture

This GS announcement must mean qual flight unwind imminent.

A significant EU deal must be in the works, so short the DXY, long everything else.

GFORCE's picture

With Greece out of the picture, do we now call it "PIIS?"