Thursday, 14 April 2011 19:21

It Should Be Obvious To Many That The Risk Of Defaulting Sovereign Bonds Can Spark A European Banking Crisis

I’m fresh back from my trip to Amsterdam where I lectured ING institutional clients and staff on the potential of a European banking collapse. Below are a few clips from the first of two lectures.

Now that the mainstream media has been reporting what BoomBustBloggers knew as fact as far back as two years ago. Today, the FT printed an article titled “Greek debt hit by restructuring fears“, whose pertinent points are as follows:

The euro tumbled on Thursday and premiums charged on Greek debt over Germany’s hit euro-era highs after the countries’ respective finance ministers talked of Greece needing more time and raised the prospect of debt restructuring.

In an interview with the Financial Times, George Papaconstantinou said Greece needed more time to convince international investors of its commitment to reform its finances.

Separately, Wolfgang Schauble, Germany’s finance minister, told Die Welt newspaper that, if a study already under way showed Greece’s debt levels were unsustainable, “further measures” would have to be taken.

When asked what those could be, he ruled out any involuntary restructuring before 2013, but warned investors could face losses after that point…  Yields on Greek two-year bonds jumped nearly a full percentage point to 17.884 per cent.

… “Greek bonds are getting crushed today due to the comments from the German finance minister and the Greek equivalent,” said Gary Jenkins, head of fixed income at Evolution Securities. “The European Stability Mechanism allows a roadmap towards restructuring, indeed it insists upon it if debt cannot be restored to a sustainable path.”

Investors… flight left yields on equivalent Greek debt 24bp higher at 13.162 per cent while Portuguese 10-year notes yielded 8.88 per cent, up 14bp. Mr Jenkins said investors expected that any restructuring would start with Greece trying to extend repayment deadlines on existing debt, or asking investors to “forgive” interest on the loans. But he warned it could take more than that. “Ultimately we believe that if the idea is to get the debt back to a sustainable level then the target will be the Maastricht treaty limit of debt-to-GDP of 60 per cent. In order to reach that level bonds will have to take a haircut of some 62 per cent,” he said.

Online Spreadsheets (professional and institutional subscribers only)

Professional and institutional subscribers should feel free to look at a variety of haircut scenarios via out proprietary sensitivity analysis for the Greek head grooming. If you remember last year when  illustrated How Greece Killed Its Own Banks!, you realize the main reason why the EU has been using the kids gloves with the Greeks. To make a long story short, let’s employ the old adage “A picture is worth a 1,000 words”…

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:

If you think those charts look painful, imagine if the Maastricht treaty was actually respected. Our models haven’t pushed passed 80% debt to GDP, but if you were to put the treaty’s debt ceiling in you would see the very definition of contagion. The following chart represents the first order consequences of a 62% haircut on Greek debt…

From ZeroHedge: Greek 10 Year-Bund spreads just passed 1,000 for the first time ever and were last trading north. Following this statement from Germany's Hoyer, it seems all hell is about to break loose for peripheral spreads.

  • *GERMANY WOULD BACK VOLUNTARY GREEK RESTRUCTURING, HOYER SAYS
  • *GREEK DEFICIT CUTTING MAY NOT BE ENOUGH, HOYER SAYS
  • *GERMANY ‘WORRIED’ ABOUT GREEK FISCAL DEVELOPMENTS, HOYER SAYS
  • *GREEK DEBT RESTRUCTURING `WOULD NOT BE A DISASTER,' HOYER SAYS
  • *GERMAN EUROPE MINISTER HOYER SPEAKS IN INTERVIEW IN BERLIN
Last modified on Wednesday, 06 July 2011 03:26

7 comments

  • Comment Link Binh Friday, 15 April 2011 16:19 posted by Binh

    "Don't hold my breath until it's too late"? Sounds like scary investment advice or some kind of paradox. I also think the word recession needs to be revised because it doesn't capture reality very well (kind of like the Case-Shiller index).

    Keep up the good work!

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  • Comment Link Reggie Middleton Friday, 15 April 2011 10:20 posted by Reggie Middleton

    Rising interest rates have been here for awhile, at least in peripheral EU states. There appears to be an effective recession already, but the higher rates won't help. As for the Volcker move, don't hold your breath until its too late.

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  • Comment Link Binh Friday, 15 April 2011 02:54 posted by Binh

    Won't rising interest rates, whenever they occur and whatever the circumstance, trigger a recession? (I agree with your argument about the "double dip" -- we never finished the first dip.) I wonder if any nation will do what Volcker did in the 80s to break the stagflation cycle? It seems that no nation wants to even consider that even though it might be beneficial in the long run because they fear something like the Great Depression, albeit on a much grander scale.

    Awesome presentation by the way! I wish I was there or could watch the whole thing.

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  • Comment Link R.R.G Friday, 15 April 2011 01:49 posted by R.R.G

    Thank you for such a clear and concise perspective. Keep up the awesome work!

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  • Comment Link Reggie Middleton Friday, 15 April 2011 01:13 posted by Reggie Middleton

    From CNBC: Finland Could Block Portuguese Bailout
    http://www.cnbc.com/id/42583186

    There is now an even chance that Finland will block euro zone aid to Portugal, a move that could throw into doubt the euro zone's ability to ensure its own financial stability, a Finnish finance ministry official said.


    Finland holds parliamentary elections on April 17 and eurosceptic parties, which oppose bailing out Portugal or even increasing the effective size of the bailout fund, the European Financial Stability Facility (EFSF), are gaining support.

    Finland is the only euro zone country where EFSF bailout loans have to be approved by parliament. In others, it is the government that decides.

    "The situation is getting tighter by the day," Finnish finance ministry adviser Martti Salmi told Reuters.

    "We got the latest polls yesterday and those who are dead against any aid to Portugal or any increase of guarantees for the EFSF get 48 percent and the others 52 percent, so it is too close to call," Salmi said.

    He said the opposition Social Democratic party, which has so far been pro-European Union and could get around 18 percent of the vote, was now saying that instead of getting loans, Portugal should restructure its debt with private investor involvement.

    Euro zone leaders repeated last month that there could be no private sector involvement in euro [EUR=X 1.4475 -0.001 (-0.07%) ] zone sovereign debt restructuring until after mid-2013, when the single currency area will launch its permanent bailout fund, the European Stability Mechanism.

    The Euro Zone's Worst Government DebtBailouts and the EU’s Tea Party MomentEU Debt Crisis Boosting Far Right
    "I have been touring the country, I was in 14 cities in the last few weeks and a lot of people are unwilling to enter into any rational debate. The are simply saying: it is wrong to help Portugal, it was wrong to help Greece, we should just let them go into bankruptcy," Salmi said.

    Finnish Block Might Affect Others

    If Finland blocks the Portuguese bailout, estimated by the European Commission at 80 billion euros, this could strengthen opposition to the bailout in Germany and cause new turmoil in debt markets, as it would signal that the functioning of the EFSF was impaired.

    "We might see that the financial stability of the euro zone as a whole is in danger in some way," Salmi said.

    Representatives from the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) have been in Lisbon since Tuesday to put together the aid package for the slow-growing, highly indebted country.

    EU Economic and Monetary Affairs Commissioner Olli Rehn, himself a Finn, acknowledging the rising opposition to the Portuguese bailout in Finland, called on Finns last week to show responsibility for the single currency area.

    A euro zone source has said that even if Finland decided not to take part in the Portuguese bailout, its share of guarantees for EFSF borrowing, about 1.4 billion euros ($2.03 billion), could be redistributed among the other euro zone members.

    But Salmi said that because bailouts required unanimity in the EFSF, such a solution would entail modifying the EFSF agreement, and this could face more trouble in several euro zone parliaments where it would have to be approved.

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  • Comment Link Reggie Middleton Friday, 15 April 2011 01:03 posted by Reggie Middleton

    Thank you. The audience received the presentation very well. There really weren't any major surprises, at least none that were presented in these short clips, there's 3.5 hours of presentation material and some of it hits pretty hard. I'm apparently rather popular in the Netherlands.

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  • Comment Link H.Kwint Thursday, 14 April 2011 20:48 posted by H.Kwint

    Nice presentation, well done! How did the audience react?

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