Tuesday, 23 November 2010 20:03

Merkel Points to `Serious' Bailout Risk as Spanish Bonds Drop, Reggie Middleton says "Ya Damn Skippy" - Here's How We Called It

I have been warning of this potential in Spain for nearly two years (January of 2009, reference Reggie Middleton on the New Global Macro – the Forensic Analysis of a Spanish Bank after a trip to the Costa del Sol by way of Málaga). I will spend the Thanksgiving holidays working on the Irish and Spanish haircut updates and fine tuning the contagion model for subscribers and I will attempt to publish the analysis in a very rich format (with dynamic models, graphics, video, etc. on BoomBustBlog, Barnes and Noble Nook/Kindle via ebook format, and through YouTube)  On that note, Bloomberg reports: German Chancellor Angela Merkel said the prospect of serial European bailouts was “exceptionally serious,” sending the euro to a three-month low as officials estimated saving Ireland will cost 85 billion euros ($114 billion).

Irish bonds dropped and the premium that investors demand to hold Spanish debt over German counterparts jumped to a euro- era record as the relief rallies triggered by Ireland’s Nov. 21 aid request evaporated. Traders are now betting the turmoil that started in Greece a year ago will spread to Portugal and Spain.

“The markets currently have virtually zero confidence that the bailout in Ireland will solve the European crisis,” Charles Diebeland David Page, fixed-income strategists at Lloyds TSB Corporate Markets in London, said in a note today. “With markets effectively in a position to dictate policy, the risk is that the credibility crisis shifts to more sizeable European Union countries and thereby poses a greater risk to the system as a whole.”

Contagion is spreading through the euro region as Ireland hammers out an aid package with the EU and the International Monetary Fund to save its banking system. The European Commission estimates Ireland may need 85 billion euros, according to two officials who were on a Nov. 21 conference call of finance ministers. Of the total, 35 billion euros would go to banks and 50 billion euros to help finance the government.

The euro dropped 1.8 percent to $1.338 as of 4:55 p.m. in London. The yield on Ireland’s 10-year bond rose 35 basis points to 8.65 percent. The spread on Spanish 10-year bonds over bunds rose 28 basis points to 236 basis points.

Merkel Risks

Merkel today chose to highlight the risks facing the euro even as bailout talks destabilize Ireland’s government. Speaking in Berlin, she said while she didn’t want to “paint a dramatic picture,” it would have been hard a year ago to “imagine the debate” now taking place in Europe. The German leader is stressing the threat to the euro posed by indebted member countries and is pushing German plans to make investors help pay for any future crisis in the currency area.

“I won’t let up on this because otherwise that primacy of politics over finance can’t be enforced,” Merkel said. “It remains our task to keep calling for tough measures and tough conditions, but also to express clear support for the euro.”

Merkel’s stance has drawn opposition from European Central Bank President Jean-Claude Trichet and leaders in Spain and Greece, who say it risks derailing euro-area nations’ deficit- cutting efforts.

In other words, Merkel is being too damn honest and forthright in her public pronouncements. So be it. This is an excerpt of what we used to prep and warn paying subscribers regarding Spain since the beginning of the year (excerpted from File Icon Spain public finances projections_033010):

In short, not only is Spain's domino about to drop, but it will drop for practical fundamental reasons. Subscriber's see:

File Icon A Review of the Spanish Banks from a Sovereign Risk Perspective – retail.pdf
File Icon A Review of the Spanish Banks from a Sovereign Risk Perspective – professional

File Icon Ireland public finances projections

File Icon Irish Bank Strategy Note

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.
Last modified on Tuesday, 23 November 2010 20:05