In January of 2009 (reference Reggie Middleton on the New Global Macro – the Forensic Analysis of a Spanish Bank ), and after a trip to the Costa del Sol by way of Málaga I became highly suspicious of the spillover effects of bubble credit and excessive reliance on construction that the European nations had and absorbed from the private sector banks. At first this was focused on Spain, but then my team of analysts and I widened our scope to all of Europe, and found that there was a contagion waiting to manifest. This was a full year and a half before most even admitted there was a pandemic problem (and to this day, there are still some naysayers). Here’s a quick time line and link fest of all of the misunderstandings, misinformation, disinformation and outright lies that have led us up to this point…
Around February 7, 2010, many sell side analysts and geo-political pundits stated that there was no European sovereign debt “crisis”, not to mention a “pan-European” crisis. I responded with The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, , not a localized not a, not localized one. Of course, this was absolute blasphemy within the circles of those smart guys who knew what they were talking about. I then went on with What Country is Next in the Coming Pan-European Sovereign Debt Crisis? – illustrates the potential for the domino effect and followed up with:
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.
More and more “experts” on the matter explained how the situation is overblown- Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire!
“The worst of Greece’s financial crisis is over and other European nations won’t follow in its path, said former European Commission President Romano Prodi.“For Greece, the problem is completely over,” said Prodi, who was also Italian prime minister, in an interview in Shanghai today. “I don’t see any other case now in Europe. I don’t think there is any reason to think the euro system will collapse or will suffer greatly because of Greece.””
Reggie says “Liar, Liar, Pants on Fire”. In all seriousness, while I don’t truly believe Mr. Prodi is lying, he is also obviously ignoring the facts as they currently exist, whether purposefully or in error. Let’s walk through a few excerpts from the most recent addition to the Pan-European Sovereign debt crisis.
Of course, shortly after that, Greece and the Greek Banks Get the Word “First” Etched on the Side of Their Domino. Of course, Greece stated that they never needed a bailout, consistently until… You know… They were bailed out – Greek Soap Opera Update: Back to the Bailout That Was Never Needed? It really didn’t help Greece’s perceived funding costs as much as expected, The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!! If anyone would have read BoomBustBlog, they would have known since January that Greece Is Well On Its Way To Default, and Previously Published Numbers Were Waaaayyy Too Optimistic! You see, the problem is that most of the government’s in the EMU are outright lying about their fiscal situations, and nearly all of them are overbanked.
- Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe
- Moody’s Follows Suit Behind Our Analysis and Downgrades 4 Greek Banks
Well, I guess being overbanked is just one of their problems. Accuracy and honesty in the accounting of their assets and liabilities may have something to do with the problem:
- Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!
Now, everyone held Ireland up as a poster child of how do conduct a successful austerity program – Many Institutions Believe Ireland To Be A Model of Austerity Implementation But the Facts Beg to Differ! The writing was clearly on the Wall for Ireland as far back as April. For some reason, everyone was either unrealistically optimistic or simply late to the party – LTTP (Late to the Party), Euro Style: Goldman Recommends Betting On Contagion Risk In Portuguese, Spanish And Italian Banks 3 Months After BoomBustBlog.
A clear, objective approach would have warned all to Beware of the Potential Irish Ponzi Scheme! and would have made clear that The Daisy Chain Effect That I Anticipated Appears To Have Commenced! I introduced the BoomBustBlog Sovereign Contagion Model because Europe’s First Real Test of Contagion Quarrantine Was Failing, and BoomBustBloggers Should Doubt the Existence of a Vaccination. I declared in May that BoomBustBlog Irish Research Becomes Reality and the mainstream financial news reports on November 22, that BoomBustBlog was one point. From Bloomberg:
Ireland became the second euro country to seek a rescue as the cost of saving its banks threatened a rerun of the Greek debt crisis that destabilized the currency. The euro rose and European bond risk fell.
The aid, which Irish officials said as recently as Nov. 15 they didn’t need, marks the latest blow to an economy that more than doubled in the decade ending in 2006. The bursting of the real-estate bubble in 2008 plunged the country into a recession and brought its banks close to collapse. With Irish bond yields near a record high, policy makers are trying to keep the crisis from spreading.
“Clearly because of the size of their loan books, the huge risks they took, they became a threat not only to the state but to the” entire euro region, Lenihan told Dublin-based RTE radio in an interview today. “The banks will be downsized to the real needs of the Irish economy” to “Irish consumers and Irish businesses. That has to be the primary focus of Irish banks.”
The whole in the Irish banking system represents c. 50% of the entire financing needs of the country itself…
The U.K. and Sweden may contribute bilateral loans, the EU said in a statement. Lenihan declined to say how big the package will be, saying that it will be less than 100 billion euros. Goldman Sachs Chief European Economist Erik Nielsen said yesterday the government needs 65 billion euros to fund itself for the next three years and 30 billion euros for the banks.
Talks will focus on the government’s deficit cutting plans and restructuring the banking system, the EU said in a statement. Irish Prime Minister Brian Cowen, who spoke at the same press briefing as Lenihan, said the banks will be stress tested. Ireland nationalized Anglo Irish Bank Corp. in 2009 and is preparing to take a majority stake in Allied Irish Banks Plc, the second-largest bank.
Lenihan and Cowen appeared minutes after finance chiefs issued a statement endorsing an aid request to calm markets. Allied Irish emphasized the fragility of the system on Nov. 19, reporting a 17 percent decline in deposits this year.
The reality of the situation is that we probably already have a run on the Irish banking system which is the first step in contagion.
“In the short term, it will stabilize the situation, there’s no doubt about that,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, who estimates a package of between 80 billion euros and 100 billion euros. “But as we’ve seen in the case of Greece, uncertainty will remain.”
Actually, Greece has shown us that yields will not drop as the result of a bailout package as long as uncertainty remains. As a matter of fact, in some cases, yields have actually increased.
The package for Ireland will total as much as 60 percent of gross domestic product, compared with 47 percent for Greece.
…The bailout follows two years of budget cuts that failed to restore market confidence as the cost of shoring up the financial industry soared.
What does this tell us? Well, for one, Ireland had some of the staunchest cuts in the name of austerity, and it was done squat in preventing this (continuation of a) bailout event from happening, other than induce material hardship upon the Irish populace. With this new package that is even bigger than Greece’s what will become of those Irish citizens who will be asked to take even more to the chin. See If the World Knew What BoomBustBlogger’s Know, Would Ireland Default Today? Wednesday, November 17th, 2010 for a deeper understanding of what I see is going on here.
Lenihan cancelled bond auctions for October and November and announced 6 billion euros of austerity measures for 2011 on Nov. 4 in a bid to restore investor confidence. Those efforts failed after German Chancellor Angela Merkel triggered an investor exodus by saying bondholders should foot some of the bill in any future bailout.
The risk premium on Ireland’s 10-year debt over German bunds, Europe’s benchmark, fell to 523 basis points today. It widened to a record 652 basis points on Nov. 11, with the yield reaching a record 9.1 percent. In 2007, it cost Ireland less than Germany to borrow. Its 10-year spread then fell to as low as 77 basis points less than bunds. The ISEQ stock index has plunged 70 percent from its record in 2007.
Ireland will draw on the 750-billion-euro fund set up by the EU and IMF in May as part of the Greek bailout to protect the currency shared by 16 countries.
As implied above, either the senior bondholders or the Irish populace will have to lose an inch of skin off of their backs. It’s going to hurt somebody, and its going to hurt them a lot. Who is more sacrosanct, bondholders or people?!?!?!?!?!?
Irish officials initially resisted pressure from the EU to take any aid, saying they were fully funded until the middle of 2011. European leaders sought to head off contagion from Ireland and reduce pressure on the European Central Bank to prop up the country’s lenders by providing them with unlimited liquidity.
Cowen defended his reversal on the need for aid. “I don’t accept I’m the bogeyman,” he said. “Now circumstances have changed, we’ve changed our policies.”
Ireland and Cowen tried to wait out their problems until the contagion took down Spain, Italy, or Portugal first. That way, there would be less political and market-based fallout out for the Irish acceptance of aid. This has obviously not worked for Ireland (as we indicated in BoomBustBog in the beginning of the year) was next in line. Of course, this does not let those other nations off the hook. As a matter of fact, we get to experiment in whether the ability to print your own currency allows for those other overbanked nations to outperform those who are hooked into the Euro. The UK should erect a shrine of homage to Soros for forcing them our of the EMU…
Yields on bonds of Spain and Portugal have jumped amid concern that fallout from Ireland would spread. The extra yield that investors demand to hold Portuguese 10-year bonds instead of German bunds climbed to a record 484 basis points on Nov. 11.
“It probably won’t halt contagion. The sovereign crisis isn’t yet over,” said Sylvain Broyer, chief euro-region economist at Natixis in Frankfurt. “Ireland is in the middle of a difficult crisis.”
“Halt contagion”??? The contagion is already here and in full motion. It is far too late to halt it. Most pundits and analysts have yet to even identify it! The contagion movements will crawl along the lines of financial, economic, geo-political and socio-economic lines that may dumbfound those who rely solely on financial analysis and the reportings of the sovereign states that have shown they are less than forthright. This is the reason why I threw so many man/months into the development of the proprietary BoomBustBlog contagion model in the beginning of the year.
The BoomBustBlog Sovereign Contagion Model
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.
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 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.
Paying subscribers should review these models in detail, for we will be making much use of them in the near future.
Sovereign Contagion Model – Retail – contains introduction, methodology summary, and findings
Sovereign Contagion Model – Pro & Institutional – contains all of the above as well as a very detailed methodology map that explains what went into the model across dozens of countries.
As promised (although a little late) I will be attempting to deliver the Ireland haircut analysis by the end of the day. Things have changed since Ireland is taking on additional debt. Many smart pundits state that a default or restructuring may not help Ireland sufficiently enough to overcome the stigma of a default in the market. I say a) the market’s memory is proven to be amazingly short, b) they will eventually have very little choice, and c) they will have plenty of company for this is the 2nd nation in the EMU to get bailed out that didn’t need a bailout. There are at least 5 more that definitely don’t need a bailout! When they get bailed out it will overwhelm the faux safety net that is being erected around the socialization of these private losses. Readers, retail subscribers and particularly professional and institutional subscribers (who will have access to the bulk of the analysis) should stay tuned for the deliverance of the “Fiery Sword of Truth!”