Wednesday, 02 February 2011 12:28

First Tunisia, Then Egypt, Now Yemen: Will This Reach The Powder Keg That Is The EU & What Will Happen If It Does?

[caption id="" align="alignleft" width="360" caption="Photo: Getty Images"][/caption]

As soon to be ex-president Mubarak demonstrates that he has essentially lost control of

Attention subscribers: A new subscription document has been released - File Icon Potential Spillover Effects from the Middle East to the EU.

his country, as is exemplified by the multi-million man march in the streets of Egypt, it brings to mind one of the major contributors to financial contagion, and that is government instability.The uprising in Egypt, brought over from Tunisia (whose president lost power) has now spread to Yemen: Yemeni president pledges not to seek another term:

Yemen's U.S.-backed president, in power for more than three decades, pledged Wednesday not to seek another term in office in an apparent attempt to defuse protests inspired by Tunisia's revolt and the turmoil in Egypt.

As I have stated in my posts over the last few days, financial contagion can spread rapidly and from relatively unexpected origins. The debt situation in the EU is a powder keg simply waiting for an ignition spark as the ECB and stronger EU parties attempt to spray water on the pile of gunpowder from an aerosol can.

If the middle east continues on the path that it currently is, it can inject contagion directly into the EU powder keg. I have highlighted for subscribers the paths using our contagion model that takes into account social unrest.

Now, lets reference the subscription “BoomBustBlog Sovereign Contagion Model“, wherein we spent many analyst man/months to create a realistic model to capture the potential for social unrest, financial and economic contagion as they could skip across sovereign borders, continents, asset classes and hemispheres. What we set out to do was to adjust the pathways of apparent pure financial contagion with several, real world factors.

So what could happen if the Middle East unrest pierces the EU border from a contagion perspective?

We have a very strong idea of what country will get hit first, and we came to this conclusion by connecting the dots. That, of course, doesn't mean that that country will be alone in suffering the contagion effect. There are those countries with excessive internal sovereign exposure. The Greek banks have 226% of Tier 1 capital exposed towards their own sovereign debt. In How Greece Killed Its Own Banks! I illustrated the folly of such a high concentration by graphing the result of a haircut on said portfolio...

Well, the answer is…. Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…


The same hypothetical leveraged positions expressed as a percentage gain or loss…


When I first started writing this post this morning, the only other bond markets getting hit were Portugal’s. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:

I also outlined various haircut scenarios for Greece, reference Rumor Has It That The Germans Are Starting To Consider Real World Solutions To The Greek Debt Dilemma – Restructuring, Exactly As We Anticipated!.

Well, we have updated our haircut analysis to take into consideration cross border contamination, and it doesn't look very pretty if things start flowing. Subscribers can download the document here: File Icon Potential Spillover Effects from the Middle East to the EU. The graph below is an excerpt from said document. Keep in mind this is a depiction of a Greek default, and does not incorporate the contagion that will invariably lead to the domino effect of other sovereigns feeling the pressure and/or defaulting.



Last modified on Wednesday, 02 February 2011 13:50

1 comment

  • Comment Link black Saturday, 05 February 2011 07:23 posted by black

    Well, we have updated our haircut analysis to take into consideration cross border contamination, and it doesn’t look very pretty if things start flowing.

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