Tuesday, 04 May 2010 13:40

Introducing The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on the money for 5 months straight!

Anybody who has been following for the last fiscal quarter or so (or has seen my Spanish bank work in 2009) knows that I believe that the EMU as it stood in 2009 would probably be non-existent by the end of 2010. All of the pundits who proclaimed that the European debt crisis was over with the mere declaration that Greece may receive some additional debt either were abjectly lying or truly didn't understand the gravity of the situation. To be honest, there are a lot (and I mean a whole lot) of data points, angles and contingencies to grasp thus it is not necessarily easy. Then again, isn't that what these market professionals get paid for.

Very early in the year, I virtually guaranteed that the Greek banks would fall, or at least have to be rescued (a 2nd time) before they fell. I practically promised it. In the news today...

Lagarde to discuss Greece support with banks: French Finance Minister Christine Lagarde will meet with bank leaders on Wednesday to discuss how its banks could participate in the Greek rescue package. Lagarde told the French parliament the country's banks will reiterate their support for the rescue process on Wednesday but she said tomorrow's meeting could lead to them taking on a more active role, along the lines of what German banks have done. French banks have so far not been asked by the government to participate directly in the Greek rescue package, two sources in France's banking sector said earlier on Tuesday. They have only been asked to maintain their exposure to Greece and have agreed to do this, the sources said. "Nothing beyond this has been requested by the government," one of the sources told Reuters. France has overall the highest exposure to Greek debt, with about $75.2 billion worth of assets in total, according to Bank of International data as at end-2009. Germany's top banks and insurers offered support on Tuesday mainly by keeping open credit lines to banks and by agreeing not to sell Greek bonds for the duration of a wider IMF-led bailout. Germany's Finance Minister Wolfgang Schaeuble said that German financial firms had agreed to buy bonds issued by state controlled bank KfW as a way to help finance the bailout. Deutsche Bank Chief Executive Josef Ackermann said it was important to extinguish the fire in Greece and pledged to help the country. Ackermann is helping to coordinate efforts by the private sector to support the Greek rescue package.

I suggest one references my post, How Greece Killed Its Own Banks!.

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)…

image001

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

image003

This was quite easy to see coming as those who downloaded the following subscription material can attest:

This will get much, much worse before it starts to get better. Even those who chose not to pay for the research had plenty of free research to see the path of current events months in advance, they just didn't get the specific banks/securities referenced with fundamental value ranges. Reference:

  1. The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a localized one.

  2. What Country is Next in the Coming Pan-European Sovereign Debt Crisis? – illustrates the potential for the domino effect

  3. The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. – attempts to illustrate the highly interdependent weaknesses in Europe’s sovereign nations can effect even the perceived “stronger” nations.

  4. The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries

  5. Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?

  6. Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire!

Here are some more MSM news clips that drive the points home:

Oh yeah, Spain. This is where our hard core stuff truly comes into play - Spain public finances projections_033010 - real answers to real questions, without the bias and BS.

So, were the opportunities described actionable? Let's take a look...

300% gains on STD June '10 12.5 puts

std 5-4-2010

100% to 150% on the NBG Aug 2.5s

nbg 4-3-2010

150% to 300% or so on BBVA Oct. 15 puts.

bbva 4-4-2010

And there's plenty more to go under several different opportunities (subscription only)...

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.

Latest Pan-European Sovereign Risk Non-bank Subscription Research

The Pan-European Sovereign Debt Crisis, to date (free):

1.      The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a localized one.

2.      What Country is Next in the Coming Pan-European Sovereign Debt Crisis? – illustrates the potential for the domino effect

3.      The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. – attempts to illustrate the highly interdependent weaknesses in Europe’s sovereign nations can effect even the perceived “stronger” nations.

4.      The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries

5.      The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!

6.      The Beginning of the Endgame is Coming???

7.      I Think It’s Confirmed, Greece Will Be the First Domino to Fall

8.      Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!

9.      Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?

10.   Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire!

11.   Germany Finally Comes Out and Says, “We’re Not Touching Greece” – Well, Sort of…

12.   The Greece and the Greek Banks Get the Word “First” Etched on the Side of Their Domino

13.   As I Warned Earlier, Latvian Government Collapses Exacerbating Financial Crisis

14.   Once You Catch a Few EU Countries “Stretching the Truth”, Why Should You Trust the Rest?

15.   Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!

16.   Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe

17.   Moody’s Follows Suit Behind Our Analysis and Downgrades 4 Greek Banks

18.   The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!!

19.   How BoomBustBlog Research Intersects with That of the IMF: Greece in the Spotlight

20.   Grecian News and its Relevance to My Analysis

21.   A Summary and Related Thoughts on the IMF’s “Strategies for Fiscal Consolidation in the Post-Crisis

22.   Euro-Gossip Debunked, Courtesy of Trichet and the IMF!

23.   Greek Soap Opera Update: Back to the Bailout That Was Never Needed?

24.   Many Institutions Believe Ireland To Be A Model of Austerity Implementation But the Facts Beg to Differ!

25.   As I Explicitly Forwarned, Greece Is Well On Its Way To Default, and Previously Published Numbers Were Waaaayyy Too Optimistic!

26.   LTTP (Late to the Party), Euro Style: Goldman Recommends Betting On Contagion Risk In Portuguese, Spanish And Italian Banks 3 Months After BoomBustBlog

27. Beware of the Potential Irish Ponzi Scheme!

28. How Greece Killed Its Own Banks!


Last modified on Thursday, 23 February 2012 08:11

18 comments

  • Comment Link hmc Thursday, 06 May 2010 16:33 posted by hmc

    @shaunsnoll - thanks for the help. I was able to get PCY JUN 19 $25 PUTs first thing this morning for $0.30; before they jumped to $0.45! I know I should buy the longer dated PUTs; but I felt like rolling the dice ... lol

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  • Comment Link Reggie Middleton Wednesday, 05 May 2010 14:53 posted by Reggie Middleton

    That is very sage advice, re: puts. Remember, you can always resell unused time value, so it is never money down the drain. The only reason I go short dated is to get a big, leveraged bang for the buck, but you have to be right both on the fundamental move and the timing - something that is not very easy to do.

    I have a lot of research coming on board for subscribers over the next few days. It's a good time to be a boombustblogger!

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  • Comment Link shaunsnoll Wednesday, 05 May 2010 14:45 posted by shaunsnoll

    I never wish I had purchased less time on puts so I usually purchase out about as far as I can go. I would buy puts one or two strikes out of the money for something like this. at the money options have the highest delta so you want them one or 2 strikes otm to get that delta when a move happens and otm options benefit most from implied vol spikes so that is my thinking there.

    There are so many bond etfs. A simple google search will turn up many and then you can choose which one fits your needs. Just try to make sure it is sovereign gov bonds that are not denominated in dollars and try to get one with the highest duration and longest maturity you can find since those will get wiped out the worst.

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  • Comment Link hmc Wednesday, 05 May 2010 10:59 posted by hmc

    Is there an equivalent ETF for just the PIIGs or any one of them? And your strategy is to purchase PUTs correct? How far out? Thanks.

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  • Comment Link shaunsnoll Wednesday, 05 May 2010 10:06 posted by shaunsnoll

    it is one of many ETFs that are similar that I like. They have super long duration debt which will get hit the hardest and please believe that if Hungary and Spain start not being able to roll their debt over all emerging markets debt will get hit. Spread to treasury on Turkey debt for example is ridiculous. There are many similar bond etfs though so you can tailor your investment strategy to whatever etf gives you the exposure you want. I am looking for ones that are NOT in us dollar denominated foreign bonds though as if a crisis like this happens dollar will rally hard and eat some of my gains.

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  • Comment Link Reggie Middleton Wednesday, 05 May 2010 02:55 posted by Reggie Middleton

    No time on Wall Street save a very short stint getting my Series 7. I have historically performed my own analysis. Yes I did catch that story and we are looking into it as I type this.

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  • Comment Link Matto Wednesday, 05 May 2010 02:46 posted by Matto

    Wall street/analyst history? Just curious.

    Did you catch this article on 0H?

    http://www.zerohedge.com/article/european-reinsurers-hook-e100-billion-piigs-losses-munich-re-leads-list-greek-exposure

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  • Comment Link Reggie Middleton Wednesday, 05 May 2010 02:37 posted by Reggie Middleton

    I'm a technology guy and asset valuation specialist by profession, or at least I try to be.

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  • Comment Link Matto Wednesday, 05 May 2010 02:33 posted by Matto

    Thanks reggie, keep up the good work.

    The spanish bank positions have started to do me some favours.

    I understand you put this stuff together for your own account, was this your professional background as well?

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  • Comment Link Reggie Middleton Wednesday, 05 May 2010 02:29 posted by Reggie Middleton

    The historical option data is streamed from an options broker.

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  • Comment Link Reggie Middleton Wednesday, 05 May 2010 02:28 posted by Reggie Middleton

    As you know, I resist giving actual trading advice, but from a strategic perspective, this malaise has just gotten started. If the markets recover and that non-sense low volume melt-up stuff starts again, I believe it will be a prime opportunity to take advantage of the structural weakness throughout the analyszed subjects. That's a big if through. The European futures are looking very ugly as I type this.

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  • Comment Link hmc Wednesday, 05 May 2010 02:21 posted by hmc

    @Reggied - What tool are you using for the historical PUT charts? And do you think it's too late to purchase PUTs on any of your actionable PIIGs banks from your research?

    @shaunsnoll - (PCY) contains holdings from all over the world as shown below. Why do you like PUTs on this ETF?

    POWERSHARES EMERGING MARKETS SOVERIGN DEBT PORTFOLIO
    Venezuela Rep 13.625%
    Republic Of Turkey 6.875%
    Philippines Rep 9.5%
    Peru Rep 8.75%
    Brazil Federative Rep 10.125%
    Brazil Federative Rep 8.25%

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  • Comment Link Reggie Middleton Tuesday, 04 May 2010 17:59 posted by Reggie Middleton

    Ireland is probably worse off than Italy, but it is really an academic argument for once one of them fall hard the rest will get sucked into the vortex. You cannot discuss an individual PIIGS in a vacuum.

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  • Comment Link shaunsnoll Tuesday, 04 May 2010 17:54 posted by shaunsnoll

    Ireland is probably the best of the worst but why move into the best house in a bad neighborhood? spread to treasury on ireland bonds is NOT cheap imo.

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  • Comment Link map3 Tuesday, 04 May 2010 17:36 posted by map3

    Holy. Shit.

    I'm really glad this touches on the private sector to an extent as well. Some/most multinational banks are about to get 3rd degree burns, while most news outlets think this ends at PIIGS debt.

    A professor of mine talked today about how Ireland is the safest bet amongst the swine, and how there may be some value there. Unfortunately, I need an A in his class more than I need to convince him his is a tool, so I'll have to pass on the opportunity to get my words in.

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  • Comment Link Reggie Middleton Tuesday, 04 May 2010 16:29 posted by Reggie Middleton

    Thanks Shaun. I don't know why half of Wall Street doesn't join the blog, but then again I'm a bit biased, aren't I? :-)

    Remember those CEE nations that are already in a depression? http://boombustblog.com/Reggie-Middleton/1321-The-Depression-is-Here-Now-The-Pan-European-Sovereign-Debt-Crisis.html

    Well the way they planned to get out of it was to export their way to the EU nations. If you take a look at the severity of the draconian cuts that have been called aurterity measures, it should be obvious that the EU will be importing very little from the CEE, which will cause them to sink deeper into depression, dragging the banks that lent to them down as well.

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  • Comment Link shaunsnoll Tuesday, 04 May 2010 16:23 posted by shaunsnoll

    I still can't believe the quality of some of the stuff on this blog even for those who don't pay. This stuff is so much better than 99% of sell side garbage I've read. Awesome work Reggie and I couldn't agree more. If this stuff comes to fruition then today is just the beginning.

    great with the advent of ETFs now retail investors can make these kind of macro trades too. puts on PCY and the other eastern Europe bond etfs have stupid cheap vol even after today. Spain will likely be next as their real estate and banking system comes apart imo but east euro is not far behind. hungary has to roll something like 10% of their GDP in debt next month?!

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  • Comment Link Reggie Middleton Tuesday, 04 May 2010 16:14 posted by Reggie Middleton

    For all of those who think this is the banking crisis part 2, It is actually stage 1.1. The first stage never ended, the government just told you it did as it allowed risky asset prices to hit another bubble. Here's a pop quiz. What happens to a bubble in a funding crisis? And you guys thought Lehman caused some problems. I don't even think we've hit the tip of the iceberg.

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