Rosenberg Recaps The European, And Sovereign, Risk Soap Opera In Ten Paragraphs Or Less

Tyler Durden's picture

While nothing new to constant Zero Hedge readers, Rosenberg's recap in a few simple paragraphs of what is happening in the European periphery, the EMU, and with sovereign balance sheets is a must read for all recent entrants into fundamental sovereign default analysis.

First the governments bail out the banks who were (are) basically insolvent. Then these governments, especially in Europe, see their balance sheets explode and face escalating concerns over sovereign default. The IMF now predicts that the government debt-to-GDP ratio in the G20 nations will explode to 118% by 2014 from pre-crisis levels of around 80%.

Now, the ball is put back onto the banks because many have exposure to the areas of Europe that are facing substantial fiscal problems right now. According to the Wall Street Journal, U.K. banks have $193 billion of exposure to Ireland. German banks have the same amount of exposure and an additional $240 billion to Spain. Many international bond mutual funds also have sizeable exposure to sovereign debt of Portugal, Ireland, Greece and Spain as well. Contagion risks are back. Stay defensive and expect to see heightened volatility.

In a nutshell, toxic assets have basically been swept under the rug in the hopes that we will outgrow the problem. Leverage ratios across every level of society are still reaching unprecedented levels as the public sector sacrifices the sanctity of its balance sheet in its quest to stabilize the dubious financial position of the household and banking sectors in many parts of the world.

Whatever bad assets have been resolved have almost entirely been placed on the books of governments and central banks, which now have their own particular set of risks, as we have witnessed very recently in places like Dubai, Mexico, and Greece, not to mention at the state and local government level in the United States. We simply have not seen a reduction in the percentage of properties with mortgages that are “under water”, hence the FDIC has identified 7% of banking sector assets ($850 billion) that are in “trouble”, so how can it possibly be that the financial system is anywhere close to some stable equilibrium?

When accurately measured, including the shadow inventory from bank foreclosures, there is still nearly two year’s worth of unsold housing inventory in the United States, and commercial vacancy rates are poised to reach unprecedented highs, and this excess supply is bound to unleash another round of price deflation and debt defaults this year. The balance sheets of governments are rapidly in decline across a broad continuum, and it is particularly questionable as to whether Europe is in sound enough financial shape to weather another banking-related storm.

The global economy is set to cool off. Not only is China and India warding off inflation with credit tightening measures but most of the fiscal and monetary stimulus thrust in the U.S.A. and Canada is behind us as well. And, the fiscal tourniquet is about to be applied in many parts of Europe, especially the PIIGS (referring to Portugal, Ireland, Italy, Greece and Spain — these countries account for a nontrivial 37% of Eurozone GDP). Greece’s GDP has already contracted by 3.0% YoY, as of Q4, and is expected to contract 1.1% in 2010 and 0.3% in 2011 as a 13% deficit-to-GDP ratio is sliced from 13% to 3% (assuming this fiscal goal can be achieved politically). Portugal has a 9.2% deficit-to-GDP ratio that is in need of repair and Spain has a deficit ratio that is even worse, at 11.4% of GDP.

The bottom line is that even if the fiscally-challenged countries of Europe do not end up defaulting, or leaving the Union, the reality is that they will have to take draconian measures to meet their financial obligations. Devaluation was the answer in the past in Greece but it cannot rely on that quick fix this time around without leaving EMU and if it did, then that could make it even harder to service its Euro-denominated debts — at least not without a restructuring. And, if Greece did attempt at a debt restructuring, rest assured that Italy, Spain, Portugal and Ireland would be next — we are talking about a combined $2 trillion of potential sovereign debt restructuring that would more than triple the $600 billion direct cost of the Lehman bankruptcy.

This poses a hurdle over global growth prospects at a time when Asia will feel the pinch from the credit-tightening moves in China and India. And heightened risk premia will also exert a dampening global dynamic of their own in terms of economic decision-making by businesses and households alike. The intense sovereign risk concerns are not limited to Europe either. In the U.S.A. we saw CDS spreads widen out to their highest levels since the equity markets were coming off their lows last April. According to the FT, the Markit iTrax SivX [sic] index of CDS on 15 western European sovereign credits rose above 100bps on Friday for the first time ever.

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pros's picture


Outstanding analysis....

nothing to dispute.


The PIIGS (and others) must devalue and restructure--

but to whom will they sell their cheap exports...

and whose exports will be displaced?


Stranger's picture

You can't restructure the economy without trust in the currency.

Greece has to cut spending. It doesn't have the power to do anything else. I'm guessing it barely has the power to cut spending without a revolutionary uprising.

It's one of the fatal problems of democratic government that everyone has the power to increase spending, but no one has the power to cut it.

Anonymous's picture

We have the power to cut it, just not the will. This is the fate of the US as well.

While everyone enjoyed themselves while they lived beyond their means the past decade or two (or three), Americans have no tolerance for any real degree of pain or sacrifice or even delayed gratification. A nation of whimps.

If it were not so, the government would have allowed a much more painful resetting of prices over the past two years (by allowing all to fail). But someone where they got the notion did not want to reset prices and they would "demand action" to alleviate all fiscal pain possible, so the government pursues bailout and pretend and extend while pontificating about how they solving the problem ("saving" jobs, etc). This is exactly what the voters voted for and it is what the majority of voters (who happen to not pay any income taxes) want.

SimpleSimon's picture

Bent over, ankles grabbed... getting 'greeced' for the act.  Come on, you PIGS, get it over with already!!!

Rainman's picture

Pricing deflation and debt defaults are the nitro and glycerine for world economies. Impossible to dispute that reality as presented by Rosie.

All other valuations must follow this awful trend.

Cursive's picture

Well said, Rainman.  A warning to all asset holders.

crosey's picture

Clarity with simplicity....quite an elegant analysis, indeed.

rubearish10's picture

Why doesn't anyone mention or discuss the chances of "Stagflation" given the condition of "fiat" currencies among G-7's etc...? I get it on the deflation and inflation discussions but as risk assets become more risky and since larger amounts of capital demand may look to yield wouldn't "higher interest" rates come to vogue as well as Gold and excluding stocks the next time around (which may be very soon)?

AM I just out of touch, out of reality or .....maybe, right????


Anonymous's picture


if the 'fiat' currencies go south i believe there will be a massive destruction of asset values. gold is likely to do well but this will be a VERY deflationary event. i agree with rosie also.

Anonymous's picture

So, lets say that Germany and others stand firm and refuse to bailout Greece. What prevents the Grease (followed by the other PIIG-lets) from leaving th EU, defaulting on their EU debt, and telling Germany to shove the sausage?

BS Inc.'s picture

In a nuthell, toxic assets have basically been swept under the rug in the hopes that we will outgrow the problem.


I agree that this was the hypothesis. My question is how in the world ANYONE with two brain cells to rub together could have believed it at the time it was proposed as the foundation for policy? The demographic headwinds ALONE should have been sufficient to undermine the validity of the "grow our way out of it" hypothesis.

Fish Gone Bad's picture

It will be interesting to see if the United States suffers the same fate as the Soviet Union - a break up.  If that were to happen, California would actually be better off.

BS Inc.'s picture

That seems unlikely. In order to make that assumption, you have to assume that policies would change in CA after such a spin-off. That's highly doubtful. At best, CA would buy itself a few years, maybe a little over a decade, but the math would still catch up with them. Liabilities can't grow faster than assets forever. And, as the liabilities continued to grow faster than assets and taxes/fees/other revenue sources had to rise to meet them, you'd have more emigration from CA to other states.

Anonymous's picture

No break up. No way. No how. Why? Too many darn flags to replace if we drop it down to 49 stars.

fotokemist's picture

Lest we forget, there was a very serious effort at breakup of the US ~ 150 years ago.  While might does not make right, it generally does win wars.  So long as the military remains loyal to TPTB, the US will remain united.  While I am reasonably well prepared to defend myself against a small mob, I would not fair well against the First Armored Cav Division.

THE DORK OF CORK's picture

Ireland is being crushed from the cost of servicing the interest on private bank bondholders - our sovereign debt is very low by European standards and we would have no problem with this debt and would be in a even better postion if these bondholders were decapitated for the foolish risks they took.

Sovereigns are being sacrificed to shield these funds - something is very rotten in the heart of Europe as governments are representing rent seekers and not their citizens or responsible holders of capital.

carbonmutant's picture

snatched this off FT Alphaville...

“The G7 countries are completely asleep at the wheel. I looked at the information they put out from their meeting I was absolutely shocked … they seem to show no awareness at all that much of Europe is facing a serious crisis and it’s not limited to Spain, Greece and Portugal, it’s also going to include Ireland. I think Italy is also very much in the line of fire. There’s a very serious crisis inside the Euro-zone.”

Former IMF chief economist Simon Johnson commenting to the BBC about the Euro-zone crisis on Sunday.

Gussiefink-nottle's picture

The entire financial system reminds of the guy in the circus who runs up and down a line of spinning plates balanced on sticks, giving this one a twirl and that one a twirl as they threaten to stop spinning and fall to the ground.

Just how many more insolvent entities can they prop up. Amazing.

Going Down's picture

Got Shorts?


Investors increased their bets against the euro to record levels in the week to February 2, according to the latest figures from the Chicago Mercantile Exchange, which are often used as a proxy of hedge fund activity.

The build-up in net short positions represents more than 40,000 contracts traded against the single currency, equivalent to bets worth $7.6bn. It suggests that investors are losing confidence in the euro’s ability to withstand any contagion from Greece’s fiscal problems to other European countries.



Cognitive Dissonance's picture

"In a nutshell, toxic assets have basically been swept under the rug in the hopes that we will outgrow the problem."

Rosie, do you really mean "outgrow" or are you really saying "inflate our way out of the problem disguised as growth"?

"We simply have not seen a reduction in the percentage of properties with mortgages that are “under water”, hence the FDIC has identified 7% of banking sector assets ($850 billion) that are in “trouble”, so how can it possibly be that the financial system is anywhere close to some stable equilibrium?"

Denial and blissful ignorance are always effective management techniques, particularly when the population itself doesn't wish to deal with reality. The ultimate confidence game is the one we are playing on ourselves if we believe the average Joe wants to deal with the problem now rather than kicking the can down the road until they are dead and buried. This government and the Fed couldn't get away with this unless the vast majority were not (at a minimum) in silent agreement, which is how the passive/aggressive dynamic plays out in real life.

"The global economy is set to cool off."

The inevitable consequences of rampant unrestrained liquidity injections is that they become progressively less and less effective upon the system as a whole. Ultimately the entire stinking mess collapses under it's own (obese) weight.

class of 68's picture

Cognitive, have read quite a few of your comments. We agree economically and (more importantly) politically. Do you run money? if so, drop me a line.




Cognitive Dissonance's picture

My apologies but I simply must maintain anonymity. I can't mix the business of running money with the pleasure of writing and commenting, though I see both as pleasure. These two worlds must remain separate, if for no other reason than conflict of interest.

class of 68's picture

no problem, understood. I am an elec contractor in pittsburgh. best year in 08, last half of 09 (brutal) interestingly january has been very strong. albeit,

the wrong work, prisons, VA, AIR Guard, FBI, etc. have been a PM holder for many years. Am in the deflation first then serious inflation camp. was with a

CTA for many years, premium seller on the merc. that october spike last year was enough for us. lived to tell about it, actually I was still marginally profitable in 08, after that we couldn't make it work anymore. Our group was 2nd biggest seller, right after Victor. Heard some wild stroies.

jmc8888's picture

No way will they be able to cut social spending.  Riots in the streets, for 1000x times the reasons of the large scale riots of a while ago.  If they'll riot that much on that, just wait until this all hits the fan. 

What are they supposed to tell their citizens?  They must starve so bankers can live and leverage up? Yeah that will go over well. 


The debts are unpayable, and they will default, unless a bailout comes, which will just kick the can down the road.  But then again the bankers should of known that when providing the loans. 


Funny thing human beings are.  When the bankers screw everyone over to the point that gov't can't foster a society/markets to meet the needs of the people, then tell them cutting services is the only way to 'get out' of the situation, the bankers are about to get taken for a ride they've never been on before and they don't meet the minimum height requirements. 


How else to you destroy gov'ts? Besides war, it's the banks indebting the gov't to the point they can't spend anymore or else the banks won't lend them anything at whatever higher rate.  Then if you don't cut spending they'll say it'll be an even higher rate.  Extortion at it's finest, biggest, and most destructive form.   

Funny how for the banks they think the endgame is them being on top again, because the gov'ts default.  Even though they will only be defaulting for bailing the banks out and all the destruction to the physical economy that such bailouts create, not to mention the policies that led to it over the past 10-40 years.  Amazing.  But that's what happens in monetary systems.  Which by American standards, is alien to us, except for those living for the past 100 years. 


Eventually the masses will wake up to the game, my thoughts are if STUPID's aren't bailed out, Greece will be the first to tell the bankers to eff off.  It's only because of the banker's long term monetarist policies that they are that much in hock to begin with.  Or for that matter, every country in debt.  Bass ackwards thinking by the public - stoked and counted on by the bankers for generations. 

The only way the real economy is saved is if the fake one is destroyed. 


Stranger's picture

Since the bankers just print the money they loan out, and then declare the rent they collect as profit, there's really no moral reason to ever pay back the loan.

Doing so simply rewards them for their inflation and empowers them to take over the entire capital market without having produced any capital themselves.

Defaulting on all the debts owed to banks is simply just one more bubble deflating, like the stock or real estate bubbles: people declared profits that weren't real, and now they need to undeclare them.

Anonymous's picture

Spreads on Dubai wider than Greece? Hard to believe.

Anonymous's picture

Amount of net outstanding CDS on Ireland is 6B, Spain 14.5B and Portugal 9.4B. Greece's is negligible in comparison.

Default by Spain or Portugal probably will have wider implications internationally than default by Greece.

Ripped Chunk's picture

Nice summary. Some excellent comments and reflections here today.

I do not see any rabbit being pulled out of the hat here. They continue to postpone the enivitable.

Anonymous's picture

Well, $2tr, no problemo, Ben just printed that much last year alone, so he would print again to save europe non? Watch out, the chopper will be airborne any moment now, loaded with freshly inked bills.

Anonymous's picture

You heard it here:

The IMF (funded in a large part by US taxpayers) will be bailing out Greece.

Germany is far too smart to be blackmailed; so in the end, as always, it will be the US taxpayer who gets raped.

Don't believe me? Watch it unfold......

Mark Beck's picture

I am not an expert on Greece, nor do I cover the country in any investment segment, except through trade statistics. But here are some observations based on discussions.

Superficially, Greece is no different than the US, except that it does not have the power to directly debase its trading currency.

Obviously, to remain a trading partner without default, the on-going use of debt must be scrutinized. Greece was not a wise user of debt.

Well, there is only one real solution, and that is debt forgiveness. Granted it will be encapsulated in public phrases like restructuring, and involve some type of kicker from the lending governments to the exposed banks as a sovereign compensations fund.

But, for the banks and the exposed nation, default at this point in time, is probably not a solution. The banks will not like a compromise as such, but the only other option is default, which is worse. So there will be a certain amount of Poker going on until both parties show their hands.

What we really see here is the Greece government failing its people. But it is no different than the US government in this respect. The inability to be fiscally responsible, political and corporate greed, is the real driver of events.

The question always arises, for Greece why not default? My first reaction is always, yes, this would be the only real good option for the potential benefits of the debt. But then when you look closely at how Greece needs to function as a member of the community, the ultimate loser will be the bank (country) extending credit. Loser in the sense that they will not get the expected return.

I would be surprised if Greece is forced into a strategic default.

Mark Beck