Massive Bank Exposure to PIGS (sans Italy)

Recent developments in the euro area have been overshadowed by what has happened in Japan, but there have been some noteworthy news. As Ambrose Evans-Pritchard notes in an article on recent BIS disclosures, the total exposure of foreign banks to Portugal, Greece, Ireland and Spain (Italy not included) amounts to $ 2.5 trillion. That's not exactly small potatoes.


“On an "ultimate risk" basis that includes the potential loss on derivatives and credit guarantees of different kinds, the figure rises to $2.51 trillion as of September 2010, well above the headline figure of $1.76 trillion in cross-border loans. The sheer scale highlights the systemic dangers if the EU fails to stabilize the debt crisis.

Eurozone leaders agreed to boost the lending power of the EU bail-out fund on Friday, but Germany vetoed proposals for a debt buy-back scheme or an activist policy of bond purchases.

The BIS, the central bank of central banks, said in its quarterly report that Germany had $569bn of exposure to the quartet, France $380bn, and the UK $431bn.”


It will therefore not surprise anyone that both France and Germany do not want to reveal the leverage of their banks, as is proposed by 'Basel III' rules. Austria and Greece are also opposed, which tells us something about the health of their respective banking systems. Naturally, all fractionally reserved banks are de facto insolvent at all times, but some are evidently even more so.

As Bloomberg reports:


“Germany and France are fighting global rules that would force lenders such as Deutsche Bank AG (DBK) and BNP Paribas SA to reveal their reliance on debt, according to an internal note prepared by the European Commission.

The euro region’s two biggest economies are “fiercely against” proposals drawn up by the Basel Committee on Banking Supervision for lenders to reveal as soon as 2015 whether they would meet a cap on borrowing, known as a leverage ratio, that may only become binding three years later. Austria and Greece are also opposed, according to the document obtained by Bloomberg News.

The “total transparency” may put pressure on lenders to meet the leverage rules three years early, the countries argue, according to the commission document. The nations may accept publication of methods regulators use to measure “leverage risk” that don’t identify specific banks, the document says.”


Well, we already know the German banks are among the most leveraged in the world (52:1 liabilities to tangible NAV on average). Apparently they just don't want everybody to know. That might make some people nervous.

Meanwhile, over in bankrupt Ireland (it should be clear to everyone that Ireland is and will remain bankrupt, regardless of the 'bailout'. It has about €30 billion in annual tax revenues vs. a total debt level – including the guarantees for bank debts – that is nearly ten times as big. It is mathematically impossible for it to pay the debt), the banks continue to see their mortgage credit losses rise inexorably. This happens as they approach yet another – the third – 'stress test'.

According to Bloomberg:


“Irish mortgages account for more than a third of about 270 billion euros of loans that remain with the nation’s so-called viable lenders — Allied Irish Banks Plc (ALBK), Bank of Ireland Plc, Irish Life & Permanent Plc and EBS Building Society. The country’s new coalition parties are not convinced “that there has been proper transparency or full disclosure by the banks” on home-loan impairments, Alan Shatter told RTE Radio on March 7, two days before his appointment as Minister for Justice.

“There has been a continual under-estimation of loan impairments in Irish banks over the past few years,” Ray Kinsella, banking professor at the Smurfit Business School at University College Dublin, said by telephone. “I am seriously concerned about mounting loan losses in their mortgage books.”

The bad loans may be reassessed as early as this month when Ireland’s central bank concludes a third round of stress tests on the country’s lenders. The results will determine how much of a 35 billion-euro international bailout fund Ireland will need to draw down.

A year ago, Irish regulators stress-tested for a 5 percent loss rate on Irish mortgages. This year’s review “will take account of the deteriorating economic conditions and hence” loan-loss assumptions “may be higher,” said Nicola Faulkner, a spokeswoman for the central bank, by e-mail.”


This doesn't sound like Ireland's financial system is on the mend. As a result, Irish banks still depend entirely on the ECB for their funding needs. In fact, Ireland's central bank continues to effectively print money by extending unsecured 'emergency loans' to Irish commercial banks.


Outlawing Defaults and Resizing the Ponzi Scheme

Meanwhile, the prospective ECB chief Lorenzo Bini Smaghi surprised everyone on Friday by announcing that defaults should henceforth be 'forbidden' in the euro area. It's a great idea and we wonder why no-one has thought of it before. Let's just declare debt defaults illegal, presto, problem solved.


“It should be forbidden for euro zone countries to have the possibility of failing, to default or restructure their debt," Bini Smaghi, one of the ECB's most influential policymakers, said in the text of a speech to be given at Lucca's Institute of Advanced Studies.

"If the objective is to have healthy public finances it should not be allowed for a country to be insolvent."

He suggested as a longer-term plan that euro zone countries should give up the right to issue sovereign debt to avoid a repeat of the bloc's current problems.

"A way to ensure discipline is effectively binding consists of devolving, to a euro zone supranational body, the power to issue bonds for the member countries."

"The countries would no longer have the technical or political capacity to issue public debt on the market… This could be a first step towards a single European bond."


In short, this is another foray toward abandonment of fiscal sovereignty in the euro area – the primary goal of the 'tax harmonizers' whose ideal it is to milk every euro area tax cow as much as is possible.

Ireland has withstood the planned onslaught by one of the leaders of the 'harmonization gang', Germany's Angela Merkel, by refusing to budge on its low corporate tax rate (hallelujah). Hence there was also no concession on the interest rates Ireland has to pay on its bailout loans from the EFSF, whereas Greece's interest rates were lowered when it agreed to major asset sales (in this case we think the idea is actually good. The less assets a government possesses, the better. This may actually see these assets put to good economic use).

The deal agreed to by EU leaders with regards to the EFSF – the bailout fund's funding was increased to a full € 440 billion and it is now authorized to buy bonds of euro area member nations (not in the secondary market though, this remains the job of the ECB) – has temporarily eased tensions in the euro area's bond markets and lowered CDS spreads on the stricken borrowers. In short, the size of the Ponzi scheme has been increased – however, the fundamental problem of there being too much debt and not enough income to pay it –  remains as unresolved as ever.  The AP reported:


“Greece was the big winner in the markets Monday after the EU agreed to a surprisingly broad package of measures to tackle the debt crisis that has for over a year threatened the existence of the euro currency.

On the weekend, eurozone leaders increased the lending power of the bailout fund and revealed it can be used to buy bonds directly from governments in exceptional circumstances — but only if they agree to further austerity measures. They also eased the bailout terms for Greece, significantly brightening its financial outlook.

The deal took markets by surprise, especially as German Chancellor Angela Merkel had been sounding an increasingly strident tone against paying up for profligate governments.

Though analysts said the deal doesn't mean the crisis has come to an end – the governments in the so-called "periphery" have years and years of austerity ahead of them – the hope in the markets is that the EU is better prepared to deal with another debt crisis flare-up.”


Years and years of austerity? We continue to believe that this simply won't be 'politically doable' – necessary though it may be. It would of course be the best way to ensure a sound longer term economic outlook, but the medicine is likely to prove too bitter for voters.


“Ultimately only fiscal discipline and most importantly, the resumption of sustained economic growth, will resolve the crisis," said David Riley, head of global sovereign ratings at Fitch. "Last Friday's decisions by euro area heads provide more time for both, but no more than that."

That appears to be the prevailing view in the markets. The euro rose a mild 0.4 percent on the day to $1.3992, its gain buffeted by global markets' volatile reaction to Japan's massive earthquake, while bond and stock prices rallied.”


“Analysts said Greece's easier bailout terms give it more breathing space to manage its mountain of debt, though whether it does anything more than delay an inevitable default remains open to question.

"While this is a clear relief for Greece and will reduce some of the pressure on the sovereign, it is unlikely to make the market more comfortable with the stock of debt," said Jacques Cailloux, chief European economist at Royal Bank of Scotland.

The positive impact of the EU deal on Portugal and Spain was less direct. Though Portugal was helped by the prospect that the bailout fund could buy its bonds, the country could still end up requiring a rescue — after all, its benchmark bond yield remains above the 7 percent the government says is unsustainable in the long run.

The mood was darker in Ireland, whose government did not get a similar deal to that of Greece because it refused to increase its super-low corporate tax rate. Countries like France and Germany have complained that the low corporate tax effectively siphons off business from other euro countries by offering a low-cost environment for multinational corporations.

Michael Noonan, Ireland's new finance minister, defended the government's position, arguing that higher corporate taxes would hurt manufacturing and exports, making it even harder for Ireland to repay its massive debts.

"There's no way we're going to concede on the corporate tax rate as a quid pro quo for the interest rate and it's unreasonable to expect us to do that," Noonan said in Brussels, where he was attending a monthly meeting of eurozone finance ministers.

He also emphasized that Saturday's EU deal did not address Ireland's banking problem, the issue that triggered the country's financial crisis.”


Markets did react positively to the announcement – especially CDS spreads on Greek debt declined considerably –  but we can only agree with Mr. Cailloux that no-one is likely to get very comfortable with Greece's existing stock of debt. Greece is in an analogous situation to Ireland – its debtberg is simply too big and hence unlikely to ever be repaid. Of course the same can be said of almost every government debt – if not for the possibility to continually roll over debt, most governments would be forced to declare themselves insolvent. Up to a point one can always expect governments to find enough money from investors to achieve these rollovers, but as we have seen, there is a limit to this and Greece has clearly reached it some time ago.

In many other press reports it was mentioned that 'investors cheered the level of detail' coming out of the negotiations. Really? If that is so, then it apparently doesn't take much these days to satisfy investors. It must be conceded that these recent actions have once again bought more time. If that  is going to help resolve the crisis remains to be seen. As we have mentioned before, the problem with buying time and kicking the can down the road is that it can end up with even bigger holes being dug.


The Charts

Below is our usual collection of charts – as you can see, CDS spreads on Greek debt have come in quite a bit on the announcement of the EFSF deal, and so have others in sympathy. Notable exceptions to this are Ireland, and as one might expect, Japan.


1.    CDS (prices in basis points, color coded)



5 year CDS spreads on Portugal, Italy, Spain and Greece – the big decline in Greek spreads was mirrored by the rest – click for higher resolution.



5 year CDS spreads on Ireland, the senior debt of Bank of Ireland, France and Japan –  a huge spike in Japanese spreads and the 'unresolved Irish banking problem' sees the Irish spreads higher as well – click for higher resolution.



5 year CDS spreads on Belgium, Austria, Hungary and Romania – all following the 'PIGS' (sans Ireland) lower – click for higher resolution.



The Markit SovX index of CDS on 19 Western European sovereigns – pulling back a bit in concert – click for higher resolution.



2.    Euro Basis Swaps (in basis points)


There was an odd move deeper into negative territory by the one year swap – we're not sure yet if this is meaningful, but suspect it is only a short term wobble, as it wasn't mirrored in other euro basis swap maturities – click for higher resolution.


5 year euro basis swap – still not doing much as of now – click for higher resolution.



3.    Other Charts


5 year CDS spreads on Australia's 'Big Four' banks – bouncing a bit, but no major moves yet. Complacency still reigns – click for higher resolution.



5 year CDS spreads on Saudi Arabia, Bahrain, Qatar and Morocco.  Bahrain's CDS are now perking up following the invasion of Bahrain by Saudi troops and the declaration of a state of emergency by the king – click for higher resolution.


The SPX, T.R.'s VIX-based volatility indicator and the gold-silver and gold-commodities ratios. The big move in the gold-commodities ratio was evidently a warning sign for what was to come today following the further deterioration in Japan's situation – click for higher resolution.


The VIX – yesterday it was closing in on a breakout, today it has happened. This does not bode well for stocks in the near to medium term – click for higher resolution.



Charts by: Bloomberg




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3 Responses to “Throwing More Good Money After Bad – Euro Area Update”

  • Smaghi should be arrested and put in a hospital for the criminally insane at a minimum. The statement is so absurd that only an insane and dangerous idiot could have made it.

  • White eagle:

    They are brutally pushing for United States of Europe.Question is only when and whether it will be Socialist or Fascist(Corporatist) monster.Either way that will be ultimate bureaucratic triumph.
    Funny enough,at the top you have unelected people called Commission ,commissioners (reminds me of Soviet Union) and fake Parliament elected with less than 30% voters participation,effectively representing some 15% population.This will not end well.

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