In continuing with my rant on the absurdity of even pretending the Greek situation is salvageable or that Greece will somehow be bailed out without a near complete absolution of their debts, I bring forth from the BoomBustBlog archives the Sovereign Contagion Model. For those who haven't read my most posts on this topic, please review The Ugly Truth About The Greek Situation That'sToo Difficult Broadcast Through Mainstream Media [32] and Grecian Tragedy Formula, Bailout Number 3. [33]
It is my contention that Greece's significant default is a forgone conclusion. It is also my contention that media attention should be much more focused on the damage to be done by a Greek default - considerably more so than whether Greece will ultimately default of not or what type of bailout it may or may not recieve. I have been of this mindset for several years which is why I had my analyst team create the Sovereign Contagion Model below.
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I've decided to go through a portion of the model and subset of its output to spark a real, realistic discussion in the media (I will discuss this on Capital Account via RT [Russian Television] live, today at 4:30 pm).
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 comparison.
- 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.
Sovereign Contagion Model - Retail [35] - contains introduction, methodology summary, and findings- Sovereign Contagion Model - Pro & Institutional [36] - contains all of the above as well as a very detailed methodology map that explains what went into the model across dozens of countries.
What happens when you take the raw public debt exposure and you massage it for reality? Well, BoomBustBlog subscribers already know. Here's a sneak peak of just one such scenario...
(Click to enarge)
This is a scenario of a 96% chance of a Greek default, which naturally daisy chains along the EU corridor. Why do I say "naturally daisy chains" you query? Well, to begin with, the leveraged holdings of Greek bonds will take a massive, mark to market recognized loss - except for possibly the ECB who holds the most since that institution feels it can rewrite the rules. Bond investors levereaged 10 to 60 percent taking a 75%+ loss on an unlevered basis are not just underwater, they are deep sea fishing.
Then there's the human nature reality that if/once Greece defaults and does not get absolutely obliterated, other nations will wonder why they should suffer through extreme austerity measures while Greece defaults and gets to start over without paying back its debt. Hey, if he doesn't have to honor his loans, why should I? That means Portugal and Ireland will be quite reticent to suffer through high debt service and austerity while Greece doesn't.
Even if point the point above does not come to fruition (eventhough it probably would), EU-wide austerity is the same as a great recession or depression - on topr of historically unprecedented debt service. A simple glance at history reveals default is much, much wiser than suffering through a decade of austerity. Don't believe me, ask the fastest growing economy in the EU, Iceland. Don't forget to look up why Iceland is one of the fastest growing economy in the EU block as well - and they are not even in the EU. Oh yeah, that's right! They defaulted on their debt and moved forward.
Take the above into consideration as you read this article published by Bloomberg [37] today:
Royal Bank of Scotland Group Plc [38], Commerzbank AG (CBK) [39] of Germany [40] and France [41]’s Credit Agricole SA booked losses on their Greek government debt two days after creditors agreed to the biggest sovereign restructuring in history.
RBS, Britain’s biggest government-owned lender, posted a wider-than-expected full-year loss after taking a sovereign-debt impairment of 1.1 billion pounds ($1.7 billion). Commerzbank, Germany’s second-biggest lender, booked a 700 million-euro ($1.1 billion) writedown on Greek debt in the fourth quarter. Credit Agricole, France’s third-largest bank, reported a quarterly loss after 220 million euros in impairments on Greek debt.
Dexia SA and Allianz SE (ALV) [42] also announced Greek writedowns today. The nation’s private creditors agreed to a debt swap on Feb. 21, paving the way for a second bailout and averting what Deutsche Bank AG Chief Executive Officer Josef Ackermann said would have been a “meltdown” worse than the collapse of Lehman Brothers Holdings Inc.
“Earnings were hit by Greek writedowns, but at least the worst is now behind us,” said Lutz Roehmeyer [43], who helps oversee about 11.5 billion euros at Landesbank Berlin Investment in Germany’s capital. “By aggressively writing down their holdings, banks want to show that they can cope even if Greece defaults down the road.”
RBS, Commerzbank and Credit Agricole (ACA) [44] have all written down their Greek debt by at least 74 percent, in line with estimated losses in the securities’ net present value from the swap.
Hmmmm! Where have we heard this before?
... RBS shares [38] jumped 4.8 percent to 28.63 pence as of 12:06 p.m. in London [45] on optimism that Chief Executive Officer Stephen Hester [46] has completed the worst of the writedowns and as demand recovered at its U.S. business.
... Allianz (ALV) [47], Europe [48]’s biggest insurer, posted fourth-quarter earnings that missed estimates as the Munich-based company booked 1.9 billion euros of non-operating impairments on Greek sovereign debt and investments, particularly in financials, for the year.
The insurer wrote down its Greek bonds to market values at the end of 2011, representing 24.7 percent of their nominal value. Shares of Allianz were up 0.8 percent to 90.57 euros.
Dexia, the Belgian lender being broken up, reported a record loss of 11.6 billion euros today. Its writedowns on Greek sovereign debt totaled 3.61 billion euros last year, including 1.25 billion euros of impairments taken by its former Belgian bank unit before it was sold on Oct. 20. In addition,Dexia (DEXB) [49] wrote down an additional 1.01 billion euros on derivative contracts tied to the Greek debt.
... Europe’s largest lenders and insurers are likely to accede to the Greek swap because they’ve already written down their sovereign holdings and want to avert the risk of a default, analysts said earlier this week. The success of the swap depends on how many investors participate in the transaction.
Under the deal, investors will forgive 53.5 percent of their principal and exchange their remaining holdings for new Greek government bonds [50] and notes from the European Financial Stability Facility. The plan seeks to reduce Greece’s debt burden by 107 billion euros, the Institute of International Finance, which led negotiations, said earlier this week. The swap is meant to help reduce the country’s debt to 120.5 percent of gross domestic product by 2020.
Will debt at 120% of GDP work for a country thrown into its deepest recession ever by austerity measures? Will anyone know what will happen three years out, not to mention 8 years out as declared by this story? Referencing the interactive spreadsheet published earlier this week - The Ugly Truth About The Greek Situation That'sToo Difficult Broadcast Through Mainstream Media [32]:
As the premise to this story goes, this is definitely not about just Greece. Let's review the contagion chart once again...
- Australia is heavily levered into China, and any who follow me know how I feel about China. There's also speculation of an Aussi Bubble Video to Go With Your Aussie Bubble Speculation? [51]
- Austria and Belgium are highly exposed, yet never mentioned in the media
- France, held hostage by its socialist stance to its over-leveraged banks - see "BoomBust BNP Paribas? [52]" [52]For those not familiar with the banking book vs trading book markdown game, I urge you to review this keynote presentation given in Amsterdam which predicted this very scenario, and reference the blog post and research of the same:
- a research note to subscribers, The Inevitability of Another Bank Crisis [53],
- followed by blog posts on the same, see Is Another Banking Crisis Inevitable? [54], as excerpted...
- a research note to subscribers,
- Ireland heavily levered into the UK whose banking system NPA's represent 9% of GDP!
- Germany, the penthouse suite lessor of the Roach Motel, and potentially the biggest threat to Europe? See The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You... [55]
- Japan: Highest debt outside of Zimbabwe, will force Japan to sell holdings to manage debt, driving up interest rates worldwide???
I can go on, but I think many have already got the message.