Tuesday, 23 November 2010 15:03

Merkel Points to `Serious' Bailout Risk as Spanish Bonds Drop, Reggie Middleton says "Ya Damn Skippy" - Here's How We Called It

I have been warning of this potential in Spain for nearly two years (January of 2009, reference Reggie Middleton on the New Global Macro – the Forensic Analysis of a Spanish Bank after a trip to the Costa del Sol by way of Málaga). I will spend the Thanksgiving holidays working on the Irish and Spanish haircut updates and fine tuning the contagion model for subscribers and I will attempt to publish the analysis in a very rich format (with dynamic models, graphics, video, etc. on BoomBustBlog, Barnes and Noble Nook/Kindle via ebook format, and through YouTube)  On that note, Bloomberg reports: German Chancellor Angela Merkel said the prospect of serial European bailouts was “exceptionally serious,” sending the euro to a three-month low as officials estimated saving Ireland will cost 85 billion euros ($114 billion).

Irish bonds dropped and the premium that investors demand to hold Spanish debt over German counterparts jumped to a euro- era record as the relief rallies triggered by Ireland’s Nov. 21 aid request evaporated. Traders are now betting the turmoil that started in Greece a year ago will spread to Portugal and Spain.

“The markets currently have virtually zero confidence that the bailout in Ireland will solve the European crisis,” Charles Diebeland David Page, fixed-income strategists at Lloyds TSB Corporate Markets in London, said in a note today. “With markets effectively in a position to dictate policy, the risk is that the credibility crisis shifts to more sizeable European Union countries and thereby poses a greater risk to the system as a whole.”

Contagion is spreading through the euro region as Ireland hammers out an aid package with the EU and the International Monetary Fund to save its banking system. The European Commission estimates Ireland may need 85 billion euros, according to two officials who were on a Nov. 21 conference call of finance ministers. Of the total, 35 billion euros would go to banks and 50 billion euros to help finance the government.

The euro dropped 1.8 percent to $1.338 as of 4:55 p.m. in London. The yield on Ireland’s 10-year bond rose 35 basis points to 8.65 percent. The spread on Spanish 10-year bonds over bunds rose 28 basis points to 236 basis points.

Merkel Risks

Merkel today chose to highlight the risks facing the euro even as bailout talks destabilize Ireland’s government. Speaking in Berlin, she said while she didn’t want to “paint a dramatic picture,” it would have been hard a year ago to “imagine the debate” now taking place in Europe. The German leader is stressing the threat to the euro posed by indebted member countries and is pushing German plans to make investors help pay for any future crisis in the currency area.

“I won’t let up on this because otherwise that primacy of politics over finance can’t be enforced,” Merkel said. “It remains our task to keep calling for tough measures and tough conditions, but also to express clear support for the euro.”

Merkel’s stance has drawn opposition from European Central Bank President Jean-Claude Trichet and leaders in Spain and Greece, who say it risks derailing euro-area nations’ deficit- cutting efforts.

In other words, Merkel is being too damn honest and forthright in her public pronouncements. So be it. This is an excerpt of what we used to prep and warn paying subscribers regarding Spain since the beginning of the year (excerpted from File Icon Spain public finances projections_033010):

In short, not only is Spain's domino about to drop, but it will drop for practical fundamental reasons. Subscriber's see:

File Icon A Review of the Spanish Banks from a Sovereign Risk Perspective – retail.pdf
File Icon A Review of the Spanish Banks from a Sovereign Risk Perspective – professional

File Icon Ireland public finances projections

File Icon Irish Bank Strategy Note

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.

foreign claims of PIIGS

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.
Last modified on Tuesday, 23 November 2010 15:05


  • Comment Link John Friday, 26 November 2010 10:25 posted by John

    the usa does have a debt crisis that is why there is no inflation, to much debt, consumers & business are paying off debt. The but USA as a soverigne nation does not have debt crisis it has a deflation crisis

  • Comment Link John Friday, 26 November 2010 10:23 posted by John

    John, QE is not money printing, it's an asset swap with the banks, exchanging their T-bills etc for cash, there for you could argue that it is infact deflationary, as it take a longer term interest bearing asset from the banks banks and replaces it with low interest bearing cash that sits in reserves unless it gets loaned out to create income.

  • Comment Link Sebastian Thursday, 25 November 2010 12:10 posted by Sebastian

    First time i come across your blog. Interesting to read.
    Short PIIGS as large IB's/HF's have been doing since 2007 and short the EUR in size.
    Thanks for your analyses. You have even created the weightage of the short positions we all need to take on the individual European sovs.

  • Comment Link shaun noll, CFA Wednesday, 24 November 2010 17:33 posted by shaun noll, CFA

    Reggie, you think this is a systemic risk much was subprime was? Based on my research and number crunching, I can't help but feel like if countries start defaulting here it will just wipe out the entire european banking system and take many indebted emerging markets when short term interest rates chunk up a few hundred bps (Latvia, Hungary, Pakistan, Turkey, etc). I think US banking exposure is less than other countries but I can't help but feel like this could spiral out of control outside the US.

    Do you think this has the same risk as subprime from your banking research? I don't see these sovereign bonds held as frequently and as widespread as MBS/CMBS/etc and I don't see the CDS market quite as risky as it was before but then there is a lot more of a macro impact from austerity, currency implosion, increased gov borrowing costs, etc

  • Comment Link Maria dos Santos Wednesday, 24 November 2010 05:04 posted by Maria dos Santos

    "I will not let up on this because the primacy of politics over markets must be enforced"This was said by Angela Merkel Chancellor of Germany,24th November 2010.Bem Bernanke has made it his mission to bend the market to his will.All this bending,I wonder do you think there might be a break?
    So much for free markets!

  • Comment Link John Ryskamp Wednesday, 24 November 2010 01:01 posted by John Ryskamp

    But don't forget who is really in the crosshairs of the bond vigilantes: the U.S. Everyone says: oh, when you have a printing press, you never have a debt crisis. Baloney. When using the printing press makes people LOSE not GAIN confidence, then it's over. It's over. In spite of the march the U.S. is still on, toward $7 trillion of QE.

  • Comment Link Reggie Middleton Tuesday, 23 November 2010 19:29 posted by Reggie Middleton

    The UK will have their turn soon enough. They have a very big advantage over the EMU states in that they own their own printing press. As I stated in an earlier post, the UK should erect a shrine to Soros in Trafalgar Square for forcing them out of the EMU. It was the smartest move of the decade.

  • Comment Link richard in norway Tuesday, 23 November 2010 19:16 posted by richard in norway

    it's a mess. as a british guy i just wondering when it's our turn

  • Comment Link overthetop Tuesday, 23 November 2010 18:16 posted by overthetop

    Id be extremely surprised if Spain gets bailed out in the same manner as ireland and greece (soverign debt paid back at 100 cents on the dollar courtesy of german taxpayers). right after greece got bailed out merkel lost some seats in a bi election in what was supposed to be her stronghold. The german voters will not support a bailout as large as spain and merkel will pull out.

    Also the latest ecoonmic data in europe where germany has hge growth and all the peripheral countries keep suffering make it more likely that the euro region will eventually break up as the ECB is torn between the needs to two europes.

  • Comment Link Jim Tuesday, 23 November 2010 16:11 posted by Jim

    On a percentage of GDP basis, it is clear that as Spain goes, so goes the Euro (with Benelux countries and the rest). What happens, though, to Austria and Switzerland? From your past posts, their financial sectors seem equally dependent on emerging Euro and non-Euro countries in Eastern Europe. Since they border Germany and share a share common language/knowledge workers, this is a curious pivot of bad debt in Western and Eastern Europe.

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