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.
Expected higher fiscal deficit and bond maturities due in 2010 have increased the need for bond auction financing for all major European economies. Amongst all major European economies, France and Italy have the highest roll over debt due for 2010 of €281,585 million and €243,586 million, respectively.
While Germany and France are expected to have the highest fiscal deficit of €125.1 billion and €96.0 billion, respectively in absolute amount for 2010 (this is without taking into consideration any possible bailout of Greece and/or the PIIGS, which will be a very difficult political feat given the current fiscal circumstances), Ireland and Spain are expected to have the highest fiscal deficit as percentage of GDP of 12% and 11%, respectively. See our newly released Spanish fiscal analysis for a more in-depth perspective, see our premium subscriber report on Spain's fiscal condition and prospects: pdf Spain public finances projections_033010
Overall, in terms of total financing needed for 2010 (which includes 2010 bond maturities, short-term roll over debt and fiscal deficit), France and Germany top the list with € 377.5 billion and €341.6 billion, respectively while the total finance needed as percentage of GDP is expected to be highest for Belgium and Ireland at 26.3% and 22.4%, respectively.
However, the recent spate of bond auction failures across Europe is forcing governments to increase premiums on new bond auctions (higher yields), which in turn is resulting in a decline in existing bond prices.
PIIGS - A troublesome area
Now, to focus on the contagion effect of Ireland, specifically, let's borrow from our yet to be released foreign claims model in order to see who may be effected from the rush to pull capital out of extant positions to fill the leveraged NPA holes left by the banks...
Ireland has the largest claims against the UK as a percentage of the its respective GDP, the largest in the world. In the rush to raise cash to sell assets, expect some fire sales in the UK. For those who may be wondering how this may affect the UK, see our premium subscription report on the UK's public finances and prospects (recently updated to include the last round of government projections): pdf UK Public Finances March 2010
Ireland can also be expected to pull assets our of the ailing PIIGS group as well, since they are, bar none, the biggest lender to that group as a percentage of GDP. No wonder their banks are having problems. There biggest exposure? Italy! See our premium analysis of Italy's public finances and prospects: Italy public finances projection 2010-03-22 10:47:41 588.19 Kb as well as their other major exposures: Spain public finances
2010-03-31 04:41:22 705.14 Kb and Greece Public Finances Projections 2010-03-15 11:33:27 694.35 Kb.
Of particular interest may be the prospects of the various banks caught in this interwoven web (premium subscription material). To date, these analyses have proven to be right on the money:
- Greek Banking Fundamental Tear Sheet
- Italian Banking Macro-Fundamental
- Spanish Banking Macro Discussion Note
Ireland also has the second highest claims (as percent of GDP) against the central and eastern European nations, who happen to be in a full blown depression. The withdrawal of assets, banking support and credit will exacerbate both Ireland's problems and that of these nations. See The
Depression is Already Here for Some Members of Europe, and It Just
Might Be Contagious! to find that Ireland can exacerbate the problems of Austrian, Swedish and Belgian banks by pulling capital out of the CEE region, and yes, they are truly in a depression:
Austria, Belgium and Sweden, while apparently healthy from a cursory perspective, have between one quarter to one half of their GDPs exposed to central and eastern European countries facing a full blown Depression!
Click to Enlarge...
These exposed countries are surrounded by much larger (GDP-wise and geo-politically) countries who have severe structural fiscal deficiencies and excessive debt as a proportion to their GDPs, not to mention being highly "OVERBANKED" (a term that I have coined).
So as to quiet those pundits who feel I am being sensationalist, let's take this step by step.
Depression(Wikipedia): In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen as part of a normal business cycle.
Considered a rare and extreme form of recession, a depression is characterized by its length, and by abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations. Price deflation, financial crisis and bank failures are also common elements of a depression.
There is no widely agreed definition for a depression, though some have been proposed. In the United States the National Bureau of Economic Research determines contractions and expansions in the business cycle, but does not declare depressions. Generally, periods labeled depressions are marked by a substantial and sustained shortfall of the ability to purchase goods relative to the amount that could be produced using current resources and technology (potential output). Another proposed definition of depression includes two general rules: 1) a decline in real GDP exceeding 10%, or 2) a recession lasting 2 or more years.
Before we go on, let's graphically what a depression would look like in this modern day and age...
A depression is characterized by ... shrinking output and investment ... reduced amounts of trade and commerce.
In order for the CEE region to improve, it must avoid the shocks associated with financial and economic contagion from far flung regions such as Ireland. The reality of the matter is that it may not be that easy. BoomBustBlog premium subscribers may download the CEE bank exposure analysis to see which banks we feel have the highest exposure to such an incident, or more realistically, string of incidents:
Banks exposed to Central and Eastern Europe.
From an empirical perspective, Ireland is in a prime position to export contagion. Not only does it have the 2nd highest banking NPAs to GDP ratios in the developed world, it has one of the highest foreign claim to GDP rations as well. I have already demonstrated how these foreign claims just happen to be concentrated in today's problem areas, but Ireland has spread this exposure far and wide as well. It is second only to Switzerland (due to Swiss private banking industry) in claims against developed countries. It is also second only to the Swiss in its total foreign claims as a % of GDP.
Next up in my Pan-European Sovereign Debt Crisis analysis, a closer look at Spain, a thorough analysis of Ireland's public finances prospects, an empirical look at Portugal and the total Foreign claims model. To illustrate how complex the foreign claims web is, imagine the intertwined prospects presented here for Ireland, multiplied by all of the nations of economic significance in the world!
For the complete Pan-European Sovereign Debt Crisis series, see: