October 06, 2022

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

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Will someone explain to me why the world is so enamored with Goldman. It appears that their research department is now recommending clients to bet on European bank contagion risk. LTTP (Late to the Party), we first warned on European bank risk in Spain with BBVA in January of last year (The Spanish Inquisition is About to Begin...). Starting in January of this year, I went in depth into the European contagion thing when practically all of the banks, pundits, analysts and rating agencies said this was contained to Greece.

In February, I posted "The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a localized one." To wit:

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 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.

Okay, come latter day April (a full 3 and a half months later), and I read over at ZeroHedge...

Goldman's Charles Himmelberg has just reiterrated his call for Long CDS on local banks in Portugal, Spain and Italy, hedged by selling Main (iTraxx) protection. It is our view that as accounts plough into this trade and as bank spreads blow out, it will only accelerate the funding complexities, the bank runs and the inevitable collapse of the financial systems in all of the other imparied peripheral countries, ultimately leading to the collapse of the EMU. Will Goldman be accused next of destroying Europe? Stay tuned.

... With total debt around €265bn, they believe Greece is not out of the woods yet. The Greek government faces a financing gap of about €51bn during the next 12 months, and will need to enact strong fiscal tightening (up to 10% of GDP) and new reforms to re-establish growth.

... High unemployment, decreasing house prices and poor to capital markets are likely to continue to challenge firms in southern Europe, where corporate bonds are only around 7% of GDP (compared to 14% in the rest of Europe and 28% in the US). Local banks, which used to rely on a stable deposit base, will face increased competition from larger players, who are willing to diversify away from bond funding. They will also face new regulatory charges over the coming months. While we remain positive on financials as a whole, we think the local southern European banks will continue to underperform.

For these reasons, we re-iterate our recommendation to buy protection on local banks in Portugal, Spain and Italy against iTraxx Main (Exhibit 13).

 

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