Sunday, 07 February 2010 23:00

The Coming Pan-European Sovereign Debt Crisis

Banks are the epicenter of the economic crises that face the developed and emerging nations over the last few years. Many appear to have allowed the media to carry the conversation away from the banks and into sovereign debt issues, social unrest etc., but the main issue still resides in the banks. Why, you ask? Well, because every single major country conducts its finances through the banks and when those finances become stressed, the banks will be the first to show it and usually show it in an aggrieved manner since most banks are still highly leveraged.

The fact that governments worldwide have made the (generally unwise) attempt to bailout their big banks by transferring bad debts and liabilities from the private sector and bank investors to the public sector and taxpayers doesn't mean that the problem has been solved or even ameliorated. As a matter of fact, I believe the problem has now been amplified, for now we have effective increased the implicit leverage in the already excessively leveraged banking problems as well as removed the natural firewalls that may have been in place by having the problems in individual financial institution versus sitting on government balance sheets, able to affect all without the need of the "domino effect" that was feared from the Lehman collapse.

This leverage stems from the fact that most European sovereign nations are considerably "overbanked". The levered assets of the banks in many Euro-sovereign nations easily outstrip those nations' GDP's. So when the nations' banks get in trouble from bad banking practices (and a very large swath have), the nations themselves not only are helpless in attempting to truly save the banks (and instead only institute a bait and switch wherein private default risk/insolvency potential is swapped for public manifestations of the same), but are put at risk themselves for the bank is actually more of a sovereign entity than the sovereign is - at least from an economic footprint perspective. This is what happened in Iceland. If one were to take an empirical look at other nations in Europe, Iceland and Greece are merely the tip of the iceberg. I have warned about this over a year ago regarding Spain and the Spanish banks (see The Spanish Inquisition is About to Begin...), and now the chickens are coming home to roost.

As it stands now, we have the most developed nations suffering from indigestion after bailing out their oversized banking industry, with many of the allegedly balance sheet bailouts actually being illusory and liquidity-based in nature. The US is case in point here, since most banks still have untold hundreds of billions of dollars of losses still sitting on their balance sheets, and the US taxpayer is stuck with the equivalent of hundreds of billions of dollars in losses simultaneously. Accounting rules have been laxed to give the impression of record profits in lieu of what should be record losses.

We also have European countries such as the UK which has nationalized several of their largest banks, taking on significant losses on the taxpayer's balance sheet, but still facing the drag of a poorly performing banking system that is still too big for the economy as a whole. Just the non-performing assets of just the top banks in the UK amount to nearly 9% of their GDP! That is a very big chunk of dead money floating around in the system that literally invalidates X% of reported GDP. The UK also has nearly $200 billion of exposure to Ireland, whose bank's NPA's are roughly 6% of that naion's GDP, the second highest in all of Europe save the UK (who has the same problem)!

The smaller sovereign nations that failed to keep their hands on the fiscal and budget reigns during the global liquidity bubble are also facing issues. Greece is the current poster child for this scenario, having been downgraded by the ratings agencies, money and capital are fleeing from the country in a typical "run on the bank scenario", their debt being shunned by the markets with CDS exploding and the big market makers in their debt refusing accept their bonds as collateral. This is Lehman Brothers, part deux, which actually makes plenty of sense since the solution to the banks failing was the government taking the failing asset risk onto the balance sheets, hence now the governments are being seen as at risk of failing versus the backstopped private sector.

The larger sovereign nations are at risk of either having to bailout their less fortunate brethren or facing the fallout of having the repercussions of a domino effect reverberate across the EU and its major markets/counterparties. This goes deeper than some may suspect. For instance, the weakest sovereigns in the Euro area are still the central and eastern European nations, and the stronger sovereigns are heavily leveraged into these countries through their "overbanked" system. If (or when) these companies start to publicly exhibit cracks, quite possibly due to the domino effect of Portugal, Greece and Spain finally tipping, then you will find the Nordics showing stress through their banking system (the biggest CEE lenders) at a level that the countries may be hard pressed to backstop, for their banking systems are literally multiples of their GDPs.

I will attempt to illustrate the "Overbanked" argument and its ramifications for the mid-tier sovereign nations in detail below and over a series of additional posts.

Sovereign Risk Alpha: The Banks Are Bigger Than Many of the Sovereigns


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.


There is a Method to the Madness: On to my perspective of the individual sovereigns

We performed a pan-European scan to identify banks with rising loan losses from troubled
exposure. We retrieved an initial list of 510 banks and applied a number of filters based on a) Banks' assets as % of GDP b) Texas ratio c) share
price etc to arrive at 40 banks for deeper analysis.

The selected 40 banks were organized into different sets for analysis based on the country of domicile.

1) Spain - Owing to serious issues surrounding Spanish
banks, we analyzed the four Spanish banks separately. It is observed that Spanish banks are witnessing substantial increase in NPAs. Included in the list is BBVA
which we have already covered (see The
Spanish Inquisition is About to Begin...
, which has turned out to be a most profitable trade). Among the four analyzed banks, the weakest bank had the highest Texas ratio of 51.6% and rapidly growing NPAs (increasing 132.5% over the last one year). Banco Satander , Spain's largest (and arguably, strongest) bank, is also witnessing substantial
increase in NPAs growing about 95% over the last one year. The Bank's Texas ratio stands at 37.5%, although low relative to other banks
examined, is still rich and the rising provisions for loan losses are
depressing Bank's profitability. The stock has risen 86% over the last
one year and is currently trading at Price-to-tangible BV of 2.1x. Banco
Satander has an ADR. Subscribers can download a tear sheet on all Spanish banks investigated here: Spanish Banking Macro Discussion Note Spanish Banking Macro Discussion Note 2010-02-09 02:48:06 519.40 Kb).

I will continue this post with banks and sovereign stress data for Austria, Belgium, Sweden, Denmark, UK,
Greece and Italy as well as the countries in central and eastern Europe, Asia and other emerging markets over the next few days. In the meantime, let's compare Spain and Greece on an apples to apples basis...


Subjective thoughts on the Spanish Situation: Embedded structural rigidities will prolong the downturn causing the oft sought after "V shaped recovery" to become an unlikely occurrence. The very high private sector debt levels most likely exacerbated the effects of global downturn. A round of consolidation and restructuring seems inevitable as both the NPAs in its banks are increasing on a fundamental basis and the banks are forced to come clean with the true losses on their commercial and residential real estate in the form of increasing NPAs (see The
Inquisition is About to Begin...
) as well as the share of NPLs which are also increasing. PWC expected the bad loans ratio to increase to 8% by the end of 2009. It is apparent that the sector will need refinancing. however, Spain's loan-to-deposit ratio of 130% is higher than the Eurozone average of 115%, which shows Spain's high reliance of wholesale funding and securitization channels, both of which have dried up.

What is not publicly touted about Greece? Greek banks exposure to emerging Europe poses an additional downside risk to the economy (I will get into this in detail for subscribers later on this week). Public debt stood at 94% of the GDP with the current account deficit rising to 14% of the GDP in 2008 (deteriorating public fiances is another concern).

Last modified on Wednesday, 15 February 2012 11:26


  • Comment Link Josecito Monday, 21 March 2011 19:17 posted by Josecito

    I cannot answer your question on GDP, for it is starting to appear that the GDP calculations, somewhat like race, is a social construct that has relatively little bearing on empirical fact :-)

    True, it's just like the so called CORE INFLATION RATE. I see inflation everywhere. Gas is up and food is up. I live in Little Havana Miami, Florida. My favorite milkshakes (fruta bomba) now cost twice the price-4 bucks and are half the size. I've never seen this before. This is just one example of hundreds how everything has gone up in price. Inflation is taking off. From previous posts in this thread, it seems that we are moving towards some ugly increases in prices.

  • Comment Link SilverSurfer21 Wednesday, 16 March 2011 17:17 posted by SilverSurfer21

    Great read but you misspelled Sovereign in the title, lol

  • Comment Link keith taylor Thursday, 27 January 2011 05:16 posted by keith taylor

    i love your economic, political and cultural analysis.

  • Comment Link Reggie Middleton Thursday, 29 July 2010 07:11 posted by Reggie Middleton

    "There are intellectually advantaged and disadvantaged members of any group. Furthermore, race is a social construct thereby the concept of race is a non-sequitir. We all have a little bit of everyone else instead of monolithic unchangeable racial structures."

    Yes, but a social construct designed to perpetuate the current socio-economic struccture, my wise paduwan :-0

    I cannot answer your question on GDP, for it is starting to appear that the GDP calculations, somewhat like race, is a social construct that has relatively little bearing on empirical fact :-)

    The hyper-inflation, on the other hand is a foregone conclusion, but timing will be difficult. I believe will have prolonged deflation, marred by periods of nasty stagflation for the demand will not be available to support full blown inflation. This may go on for a while, as in Japan who has spent 20 years with QE and zero interest rates. If, or when, things ever do move in the opposite direction it will be nearly impossible for central bankers and politicos to turn off the spigots in time and in the right sequence, hence the potential for the hyper-inflation that you speak of.

    Just my uneducated, layman's opinion, of course.

  • Comment Link Josecito Wednesday, 28 July 2010 23:56 posted by Josecito

    Could someone answer my questions which are more important than the silliness of whether black people are smart or not? Blacks are like whites are like any other humans on Earth. There are intellectually advantaged and disadvantaged members of any group. Furthermore, race is a social construct thereby the concept of race is a non-sequitir. We all have a little bit of everyone else instead of monolithic unchangeable racial structures. I thought that by 2010 we'd be beyond this nonsense. Now, Reggie, could you answer my questions please?

  • Comment Link Reggie Middleton Wednesday, 28 July 2010 05:59 posted by Reggie Middleton

    Thanks, I think...
    I actually understand what you mean and appreciate your honesty. It is not so much cultural, as it is constant programmming, misinformation and disinformation in the media. Get to know more Black people and let your actual personal experiences take the place of media programming (ex. unplug from the matrix) and you will find you come to an alternate conclusion for a lot of topics, with race being just one of many issues that would have changed your mind on. Our nations, and worlds, economic situation being among one of them.

  • Comment Link Josh Martin Wednesday, 28 July 2010 02:05 posted by Josh Martin

    For many years, I am a bit embarrassed to admit that was "racist", not in the sense of disliking people of other races...but I disrespected the "genetic" ability of black people to do intellectual work. Since I've been reading Reggie's work, however, I realized that I was completely wrong. The issue has got to be cultural. My thoughts on this issue have reversed 360 degrees. Reggie, you are a brilliant analyst.

  • Comment Link Josecito Monday, 19 July 2010 12:13 posted by Josecito

    I guess I can answer my previous question by the following: the German and French banks can continue these games until the devaluation of the currency via inorganic emissions does not allow it. In other words, until the devaluation of the currency is insufficient to meet the current obligations. As more and more inorganic emissions of the currency are demanded to meet the current obligations, it will reach a point of hyper-inflation where not even an infinite amount of currency will meet the most minimal demands.

    Another question I have is if these assets registered by the banks appears in the GDP since investments are a component of GDP, then how is it possible that the banks list assets that are multiples of GDP? Wouldn't these investments also appear in an evaluation of GDP?

  • Comment Link Josecito Saturday, 17 July 2010 11:44 posted by Josecito

    Thanks for the heads up. Since the German and French banks list as assets those monies that are owed to them by the insolvent banks in the PIGS euro-zone, aren't then the German and French banks themselves at some level also insolvent? I am just amazed at how they are able to keep this going. I believe in one of your article or someone else speaking of a 100 trillion dollar circle jerk being run by European and American banks.

    It would seem their ability at game playing is infinite though, given the years that have gone by and the massive collapse we are all waiting for hasn't yet materialized. Is it possible to keep this game going ad infinitum?

  • Comment Link Reggie Middleton Thursday, 15 July 2010 15:18 posted by Reggie Middleton

    Thanks for the compliment. I don't have the time and the bandwidth to take on another project, but there are several noteworthy projects already on the web. For instance, has plain English definitions of most financial terms. See for NPAs:
    Non-Performing Asset (NPA)
    What Does It Mean?
    What Does Non-Performing Asset (NPA) Mean?
    A classification used by financial institutions that refer to loans that are in jeopardy of default. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset.

    Also known as “non-performing loan”.
    Investopedia Says
    Investopedia explains Non-Performing Asset (NPA)
    Non-performing assets are problematic for financial institutions since they depend on interest payments for income. Troublesome pressure from the economy can lead to a sharp increase in non-performing loans and often results in massive write-downs.

  • Comment Link Josecito Thursday, 15 July 2010 15:07 posted by Josecito

    Reggie, your infromation and knowledge is beyond belief. Could you have as a sticky somewhere definitions and your explanations. For ex. what is NPL, NPA, etc and also explanations of Tier 1 etc. Your explanation would trump anything I've seen. Wikipedia is great but sometimes their help in explaining technical economic terms in themselves necessitates help. In other words, help is needed to understand the "help". Thanks

  • Comment Link ezrasfund Wednesday, 10 February 2010 21:39 posted by ezrasfund

    What about Japan with a debt/GDP ratio that dwarfs all others? They have been the great signpost so far, pointing the way from a real estate bust to zombie banks, zero interest rates, and prolonged deflation. Will they show us where the path will lead next?

  • Comment Link Mark Hankins Tuesday, 09 February 2010 14:15 posted by Mark Hankins

    Leviticus 25:9 to be specific--all debts zeroed out every 50 years. Kondratieff rediscovered the need for debt relief on a cyclical basis ... and Stalin killed him for it.

    Sovereign nations essentially need to do a netting process, with debt forgiveness where appropriate.

  • Comment Link rahul Tuesday, 09 February 2010 14:10 posted by rahul

    Also to add (although I am not an expert), the increase in soverign spreads should tickle down in form of increased borrowing cost through wholesale funding and impact the margins. They are already thin for many of the banks and thats the last thing banks can afford. Also a question, are the charge-off rate annualized, it seems at very comfortable levels looking at the data, makes me question, why are the NPA not turning into losses.

  • Comment Link rahul Tuesday, 09 February 2010 13:52 posted by rahul

    No wonder they are rightly connoted as European PIGS ;)

  • Comment Link mm17101978 Tuesday, 09 February 2010 13:08 posted by mm17101978

    As a user who is just registered, I'm absolutely lacking quality information about the truth hidden behind the numbers that almost everybody is forgetting to mention over here (example: Italy's public debt or total debt compared to GDP). Recently, a consulting firm in the US finally issued a quite comprehensive report comparing most "developed" nations using total-debt-to-GDP ratios as a starting point. That was the only logical thing to do but outside of that report, it's nothing but silence. Thanks Reggie and yes, I agree.....

  • Comment Link Reggie Middleton Tuesday, 09 February 2010 12:50 posted by Reggie Middleton

    There's a lot more to come. I am effectively short much of the developed world. This banking/debt situation is much worse than the media is making it out to be. By using the term "contagion", they are negating the actual cause of the problem which is the inherent acceptance of boom/bust cycle economics by both the public and the private sector - with each boom and bust getting progressively worse and more correlated across national boundaries. The next time around (which is now, with global risk asset markets skyrocketing) will probably be the straw that breaks the debt camel's back. There are no issues that are contagious, the problems facing Greece are already inherent in almost all of the Eurozone, Japan, China, and the UK.

  • Comment Link Marco Tuesday, 09 February 2010 10:35 posted by Marco

    Being 31 and from Italy, I want to thank you Reggie for this great idea. Writing a series of articles about Europe as a whole from west to east in order to expose the flaws of any nation on this continent is something that was certainly needed. I'm well aware that, for example, Greece and Spain are just one slice of this issue. Italy is certainly a big part of it, whether the meltdown will gather speed in a year from now or in 5 or 10 years but given my age, I better be prepared for plenty of shocks. Keep up the great work!

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