Wednesday, 05 January 2011 09:06

This Mornings News Flow Is Essentially A "Didn't Reggie Tell Us This In Full Detail Up To Two Years Ago" Parade As Indebted Europe Continues To Rip At The Seams!

This mornings news flow is essentially a "Didn't Reggie tell us this in full detail up to two years ago" fest. Indebted Europe is falling apart for the new year just a day after the liquidity driven romp in equities. The Portugal T-Bill Yield Almost Doubles in Auction, from 3 months ago. The yield Portugal pays on its debt has increased 522% since this last year. This is after the Pan-European bailout fund was announced and implemented to put an end to such pressures. Alas.... The best laid plans. CNBC reports, as does Bloomberg:

Portugal sold six-month bills today, the first of Europe’s high-deficit nations to test investor demand in 2011 after the threat of default forced Greece and Ireland to seek bailouts last year. The government debt agency, known as IGCP, auctioned 500 million euros ($665 million) of bills repayable in July. The yield jumped to 3.686 percent from 2.045 percent at a sale of similar maturity securities in September, with investors bidding for 2.6 times the amount offered. A year ago, the country paid just 0.592 percent to borrow for six months.

Yeah, this is sustainable. What is so interesting that mathematically, a default is definitely in the Portuguese cards, but the mains stream media does not drill down on this. Why? We, at BoomBustBlog have literally given away a complete mathematical analysis that shows the default happening - in real time, and for free. See The Anatomy of a Portugal Default: A Graphical Step by Step Guide to the Beginning of the Largest String of Sovereign Defaults in Recent History Tuesday, December 7th, 2010 and The Truth Behind Portugal’s Inevitable Default – Arithmetic Evidence Available Only Through BoomBustBlog Monday, December 6th, 2010. The line of default demarcation has been drawn in the sand t 2013, but does anyone truly believe that all of these deeply indebted states will float for that long. Could you imagine your interest rates rising over 500% and continue to climb during YOUR time of need?

The inevitable truth of the matter is that several European states WILL default, and default they will. If Germany, or any other economy that still has its druthers to it decides to stand in front of said occurrence, it will likely be dragged down as well. The Germans apparently realize this. See this excerpt from our discussion on the topic regarding Ireland’s prospects for default:

… from the post wherein BoomBustBlogger Nick asked:


Do you have any reason as to why they are choosing 2013 as a deadline ? Seems like an arbitrary date.

Well, Nick, just follow the money  or the lack thereof…

So, what debt raising and servicing that was unsustainable in 2010 was lent even more debt to become even more unsustainable. The chickens come home to roost in 2013, post IMF/EU/Bilateral state leveraged into Ireland loan/Pension fund raiding bailout! What Angela in Germany was alluding to was what all in the know, well… know, and that is that Ireland is already in default and those defaults have been purposely pushed out until 2013. Angela simply (and wisely from a local political perspective, although unwisely from a global geopolitical standpoint) admitted/suggested was that the defaults will be pre-packaged and managed ahead of time. The EU politbureau insists that politics rule the day, and no prepackaged structure be in place for the Irish defaults to be. This means the potential foe even more carnage through the pipelines of uncertainty!

Click through to Portugal’s Inevitable Default as clearly calculated in the BoomBustBlog live spreadsheets, currently available for free (Portugal only, you must subscribe for the analytical models of the countries that will really set things off).

Thus, the following additional spreadsheet scenarios have been built for more severe maturity extension and coupon reduction, or which will have the maturity extension and coupon reduction combined with the haircut on the principal amount. The following is professional level subscscription content only, but I would like to share with all readers the facts, as they play out mathematically, for Portugal. In all of the scenarios below, Portugal will need both EU/IMF funding packages (yes, in addition to the $1 trillion package fantasized for Greece), and will still have funding deficits by 2014, save one scenario. That scenario will punish bondholders severely, for they will have to stand behind the IMF in terms of seniority and liquidation (see How the US Has Perfected the Use of Economic Imperialism Through the European Union!) as well as take in excess of a 20% haircut in principal while suffering the added risk/duration/illiquidity of a substantive and very material increase in maturity. Of course, we can model this without the IMF/EU package (which I am sure will be a political nightmare after Greece), but we will be recasting the “The Great Global Macro Experiment, Revisited” in and attempt to forge a New Argentina (see A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina).

Here is  graphical representation of exactly how deep one must dig Portugal out of the Doo Doo in order to achieve a sustainable fiscal situation. The following chart is a depiction of Portugal’s funding requirements from the market before restructuring…

There is also Spain: As If On Cue After My Step By Step Illustration Of A Spanish Default, Spanish Yields Climb at Auction As Pressure Continues Thursday, December 16th, 2010. In addition, as we have warned ad nauseum, Ireland. As per Bloomberg today: Irish House Price Decline Quickens in Last Quarter, Daft Says.

From Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe, see the reason why the Irish banks are done for...

This is just a sampling of individual banks whose assets dwarf the GDP of the nations in which they’re domiciled. To make matters even worse, leverage is rampant in Europe, even after the debacle which we are trying to get through has shown the risks of such an approach. A sudden deleveraging can wreak havoc upon these economies. Keep in mind that on an aggregate basis, these banks are even more of a force to be reckoned with. I have identified Greek banks with adjusted leverage of nearly 90x whose assets are nearly 30% of the Greek GDP, and that is without factoring the inevitable run on the bank that they are probably experiencing. Throw in the hidden NPAs that I cannot discern from my desk in NY, and you have a bank that has problems, levered into a country that has even more problems.


Notice how Ireland is the nation with the second highest NPA to GDP ratio. This was definitely not hard to see coming. In addition, Ireland has significant foreign claims – both against it and against other countries, many of whom are embattled in their own sovereign crisis. This portends the massive exporting and importing of financial contagion. Reference my earlier post, Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter? wherein I demonstrate that Ireland’s banking woes can easily reverberate throughout the rest of Europe, affecting nations that many pundits never bothered to consider. Irish banks will be selling off assets, issuing assets and bonds in an attempt to raise capital just as the Irish government (contrary to their proclamations) will probably be issuing debt to recapitalize certain banks. This comes at a time when the Eurozone capital markets will be quite crowded.

The Irish banks are so saddled with NPAs as to be nearly dead on their feet. Reference our default and haircut analysis piece: Here’s Something That You Will Not Find Elsewhere – Proof That Ireland Will Have To Default… Tuesday, November 30th, 2010

The BoomBustBlog Ireland Haircut Model has been posted, and it is a doozy. For those who anticipate  the Euro being a slow train wreck, it may not be so slow after all. Professional and institutional subscribers can access it here as a live, spreadsheet embedded into a BoomBustBlog  web page. Users can subscribe or upgrade to gain access. The haircut model is SOOOO damn revealing that I can’t keep it all to just site subscribers, thus I have pulled a few bits and pieces out for the general public.

As any who have been following me know, I believe that several European countries are bound to default, ie. restructure their debt. Ireland is in that camp. What makes me so sure about this? Well, its simple math. While I have calculated probable restructuring and haircut scenarios, I am not at liberty to put it out in the public domain just yet, but I can illustrate incontrovertible evidence that shows that Ireland is on an unsustainable path – a path made even more unsustainable by the recent bailout.

Let’s take a look at the cumulated funding requirement of Ireland over the next 15 years.

As you can see, the amount Ireland would have to borrow to run the country (even after harsh and punitive austerity measures) is literally more (and substantially more) than the country’s projected GDP. These GDP projections are (in part) IMF projections which I have already demonstrated to be grossly over optimistic, see Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!). As a matter of fact, the tab for Ireland is even greater AFTER the IMF/EU/Bilateral state leveraged into Ireland loan/Pension fund raiding bailout! This is what happens when you try to save a debt laden country with more debt!

Click image below to enlarge a screen shot of the model.

Common sense dictates what Bloomberg has reported next, Swiss Central Bank Excludes Irish Bonds as Collateral.

We have also warned of specific European banks as far back as two years ago. Bloomberg reports Europe Banks Race Sovereigns to Bond Investors. BoombBustBlog Subscribers should review the subscription-only material in the Pan-European Sovereign Debt Crisis series (right hand margin).

Now, Bloomberg reports Professor Rogoff Says Greece May Yet Face Default on Its Debts, but we said it first: Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire! and Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! and then the math behind it:

  1. What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates

  2. The ECB and the Potential Failure of Quantitative Easing, Euro Edition – In the Spotlight!

  3. A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina

What do you think happens when this hotbed of bad debt ignites in Europe? Do you think rates are going to continue to scrape along the bottom? Is that going to ignite the CRE and housing market? A spike in rates will drive a spike of reality through both residential and commercial property markets. Bloomberg reports U.S. Shopping Center Vacancies Rise as Unemployment Rate Climbs.

I have warned about CRE diverging from reality ever since I declared GGP insolvent in 2007, two years before their bankruptcy. I'm not alone, Davidowitz On Overt Optimism In The Retail Space And Mall REITs, Stuff Which We Have Detailed Often In The Past Friday, December 31st, 201.

There are reasons for this divergence, reference The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?, but the reasons will not survive a European derived interest rate storm. I will be speaking on this topic in person in NYC towards the end of January and in Amsterdam in the beginning of April. Any and all are invited to attend.

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Last modified on Wednesday, 05 January 2011 09:10


  • Comment Link shaun noll, CFA Wednesday, 05 January 2011 20:03 posted by shaun noll, CFA

    will be interesting to see what kind of value on the long side there is in this sovereign debt when the ish hits the fan because there will be some real blood in the streets...

  • Comment Link rfl Wednesday, 05 January 2011 18:44 posted by rfl

    I hope you get the chance to go main stream so the little guys will finally get the truth. You are to be commended and rewarded for telling the truth. This site is such a breath of fresh air! Thanks again.

  • Comment Link richard in norway Wednesday, 05 January 2011 17:15 posted by richard in norway


    the thought of 80% losses compounded by so much leverage caused my brain to shut down

    i'm really glad i don't work in finance

  • Comment Link Reggie Middleton Wednesday, 05 January 2011 17:06 posted by Reggie Middleton

    Remember, not everybody uses the leverage model like banks. Some investors do it the old fashioned way - in cash. To answer your question, supposed you had 100,000 euro and borrowed a million more euro to buy a portfolio of investments, of which 20% were said bonds mentioned above. Your loss on the bond portion of the investment would have been over 100%, in essence draining capital from the other investments and will most likely wipe out all of your equity and cause you to go insolvent but if you have regulators on your side (and you know the banks do since the Irish banks passed the European stress tests right before they were taken over by the government for the exact same reason mentioned above - the sovereign debt risk was not taken into consideration and NPAs were excessive) you can extend and pretend in the hope that you can earning your way out of the hole. Will it happen? Well, maybe in a strong economy when business is bustling. How about in an extended downturn and a meek, imagined upturn that is powered by QE and ECB liquidity measures fighting the deflationary effects of austerity measures across the continent???

    Remember, no matter what your losses, will have to pay your creditors back regardless of the performance of your investment unless you default or restructure. If one big country does it, it will daisy chain throughout the banking system, then as a result throughout the sovereign nations, possible even using the ECB or the ESFS as a transmission mechanism.

  • Comment Link richard in norway Wednesday, 05 January 2011 16:55 posted by richard in norway

    but the bondholders were offered 20% if they signed on quickly or nothing if they draged their feet, if they are leveraged up that much, is there any difference between 20% or zip

  • Comment Link Reggie Middleton Wednesday, 05 January 2011 16:47 posted by Reggie Middleton

    Of equity in that particular deal, yes. Remember that the banks have (or at least should have) is a diversified portfolio funded by leveraged capital. The 100% plus loss in sovereign debt should be offset in part by gains in other asset classes. The problem is that too many banks are highly overweighted in soveriegn debt and this debt did not have a risk rating, and was thought of as risk free. We know better than that, now don't wee.

  • Comment Link richard in norway Wednesday, 05 January 2011 16:40 posted by richard in norway

    but that's compleat wipeout

  • Comment Link Reggie Middleton Wednesday, 05 January 2011 16:34 posted by Reggie Middleton

    "Ouch!" is right. Now, leverage that 80% scalping 15 to 30 times (remember, that is the banking model for building yield into bond purchases) and you will really see some discomfort.

  • Comment Link Blankfiend Wednesday, 05 January 2011 16:30 posted by Blankfiend

    Thank you, and AMEN!

  • Comment Link richard in norway Wednesday, 05 January 2011 16:28 posted by richard in norway


    i saw a bit in the FT about haircuts for anglo bank bondholders, it seems they were forced into accepting an 80% shave, they say that its a model for the other irish banks


  • Comment Link Reggie Middleton Wednesday, 05 January 2011 16:17 posted by Reggie Middleton

    Although I don't have any specific info on the EFSF CDS, I agree wholeheartedly with the author, which is why I put so many resources into the contagion research. There is absolutely no way in the world for the Europeans to diversify out of the concentration and correlation risk that they have accepted.

  • Comment Link Blankfiend Wednesday, 05 January 2011 15:16 posted by Blankfiend

    What do you think of equating the EFSF to a big CDO? Instead of being a mix of subprime and prime mortgages, it contains sovereign bonds. Luigi Zingales did a nice piece on this at In it he mentions that a CDS will begin trading on EFSF debt in January of this year. Do you know anything about that CDS?

  • Comment Link Reggie Middleton Wednesday, 05 January 2011 15:12 posted by Reggie Middleton

    We've addressed Italy in detail for subscribers:

    Italy public finances projection,com_docman/Itemid,103/gid,297/task,doc_details/

    Italian Banking Macro-Fundamental Discussion Note,com_docman/Itemid,103/gid,288/task,doc_details/

    I don't believe Eurobonds will work, unless kicking the limping economy can is considered working. Devaluation/default will pressure rates, and probably hurt CRE. The US will benefit from the flight to safety trade, that is until it is realized that the relative safety is ephemeral. Alas, from a relative perspective the US is still better off. If the rate storm does hit the US, CRE will get crushed (more) and the derivative charade played by ETFs, REITs and banks will come to an end.

  • Comment Link Jim Wednesday, 05 January 2011 14:56 posted by Jim

    All great stuff, but Italy will have to service 10X Portugal's debt this year and 26X Ireland's! Italy and Spain will service over 5 1/2X what Greece, Ireland, and Portugal service COMBINED. However, the EU and IMF simply can not bail Italy, so that leaves only two mechanisms to re-adjust the Euro: Eurobonds and devaluation. How will this impact money flows into the dollar and the moderation or rise of interest rates over the next two to three years?

  • Comment Link John Ryskamp Wednesday, 05 January 2011 13:40 posted by John Ryskamp

    Again, the solution is clear: don't permit a market in sovereign debt. Restrict purchasers to central banks.

  • Comment Link Reggie Middleton Wednesday, 05 January 2011 12:24 posted by Reggie Middleton

    To be absolutely honest, a string of serial defaults will not be the end of the world, but a new beginning. If Europe attempts to hobble along, dragging each and every indebted nation along as a whole, it will underperform the rest of the world.

    If the weaker nations restructure, they will have the breathing room to start anew, just as every other nation that restructured did in the past. Some have been locked out of the public markets for a time, but that is the price to be paid for the lack of prudence or bad luck.

    Now, the only major difference this time around is that nearly all of the major European banks, including the ECB, are heavily leveraged and mired in overvalued sovereign securities. Any serial default or restructuring is going to hurt them bad - very bad. This is unavoidable though, unless European leaders are content trying to kick the can down the road until they find there is no more road - and then they crash.

  • Comment Link Pieter Wednesday, 05 January 2011 12:17 posted by Pieter


    Frightening figures. Do you think it is time to buy some nice things we want or need (a new washing machine, a new computer, paintings) before our savings lose their value or the euro crashes?

    Kind regards,


  • Comment Link Mark Hankins Wednesday, 05 January 2011 11:00 posted by Mark Hankins

    The press hides things. Until it can't (or until one of their bosses wants it out there).

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