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With Europe's First Real Test of Contagion Quarrantine Failing ...

... BoomBustBloggers Should Doubt the Existence of a Vaccination

Bloomberg has as a headline: Greek Quarantine Tested as Spain Vows to Combat Euro Contagion 'Madness':

Investors are already testing the euro region's efforts to contain the Greek crisis.

Greek bond yields rose yesterday above their level before the government agreed on a European Union-led bailout on May 2 as escalating protests cast doubt on its ability to drive through austerity measures. Spanish and Portuguese bonds also renewed last week's slide as investors question their ability to cut budget deficits that are among the highest in the euro area.

The equity destroying capability of this occurrence should not be underestimated. Referencing "How Greece Killed Its Own Banks!", you can see that at just 10x leverage (about 1/3rd what most European banks are currently sporting), any holder of Greek bonds are underwater (if not insolvent) on those particular purchases at offer - and that is using last weeks numbers, which look much better than the reality today!

Leveraged Bond returns

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

Leveraged Bonds Profit/Loss

Subscribers, please reference the following:

Now, back to the article for there is more of interest to discuss...

European governments are hoping that Greece's 110 billion- euro bailout will stop a crisis that Nobel Prize-winning economist Joseph Stiglitz says threatens the currency's survival. Investors are speculating that Spain and Portugal may also eventually need assistance, prompting Spanish Prime Minister Jose Luis Rodriguez Zapatero to dismiss such talk as "complete madness."...

Well, I don't know about complete madness. An excerpted page from our Spain public finances projections shows Mr. Zapatero's government has been most optimistic in his assumptions of growth and revenues.

by Economist intelligence unit are even lower at 0.8% for 2011. Economists and central bankers have also cast doubt on the plan's chances of success, saying its economic growth forecasts are too optimistic and insisting on the need for ambitious reforms to the rigid labor market to make the economy more competitive.

Spain Real GDP Growth Estimates

Spain witnessed a contraction in economic activity, with its real GDP registering a decline of 3.6% in 2009, primarily off very weak domestic demand and exports impacted by the sharp contraction in world trade. Moreover, the economic contraction had an adverse impact on the country's employment levels, with over one million jobs being lost in annual average terms. Although 40% of job losses in 2009 were in the construction industry, the adjustment spread to other industries through certain labor market inefficiencies, resulting in a sizeable social cost.

What dismissal of the debate of a Spanish bailout itself skirting the perimeters of "madness" is that despite the fact that Spain's government has pretty much based their numbers using L-La Land math, the baseline numbers that we compared them to are also prone to optimistic fantasy. Reference how rosy the outlook of the IMF and the EU were in forecasting the deficit and debt to GDP ration for teh UK, Ireland, Italy and Greece throughout this entire fiasco in "Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!"

Greece Real GDP Growth - Actuals versus IMF Estimates

Notice how dramatically off the market the IMF has been, skewered HEAVILY to the optimistic side. Now, notice how aggressively the IMF has downwardly revised their forecasts to still end up wildly optimistic.

Greece Real GDP Growth Estimates by IMF

Ever since the beginning of this crisis, IMF estimates of government balance have been just as bad...

Greece Government Balance - Actuals versus IMF Estimates

The EU/EC has proven to be no better, and if anything is arguably worse!

Greece Real GDP Growth - Actuals versus EU Estimates

Revisions-R-US!

Greece Real GDP Growth Forecasts by EU

and the EU on goverment balance??? Way, way, way off.

Greece Government Balance - Actuals versus EU Estimates

So, Mr. Zapatero, the contents of this blog post alone, contains more than enough reason to speculate on the possibility of Spain needing a bailout. If one were to actually delve deeper into our reports, many, many more reasons to speculate will emerge, and the banks contained in the Leveraged European Entities from a Sovereign Risk Perspective are justifiably suspect, for they hold a lot of debt and exposure to the most suspect of the PIIGS group. I don't think "madness" would accurately describe the speculation of Spain's need for assistance. The options market agrees, looking at the performance of the puts on exposed and high NPA Spanish banks...

NPA Spanish Bank Options

And now, back to the Bloomberg article...

Bonds Tumble

That didn't stop a sell-off in Spanish bonds yesterday. The extra yield that investors demand to buy its debt over German bunds rose 21 basis points to a 14-month high of 117.8 points. Spain's benchmark IBEX Index, the euro region's worst performer after Greece, fell 5.4 percent to the lowest since July. Portugal's spread rose 40 basis points to 247 yesterday.

Up until last week Spanish bonds did not represent drastic losses to their investors. I fear they will soon start looking like those Greek bonds charted above very soon, though.

The euro weakened 1.4 percent to $1.3011, the lowest in more than a year. The currency retreated further in Asian trading today, to $1.2961 as of 11 a.m. in Singapore.

Greek unions plan their third general strike of the year today after workers occupied the Acropolis yesterday and shut down schools and hospitals at the start of a 48-hour walk-out. Aegean Airlines SA, a Greek carrier, has canceled all flights....

'Massive' Protest

"We will continue with action as long as these measures, which go against workers and are anti-social, continue to be demanded," Stathis Anestis, a spokesman for the GSEE union, said in a telephone interview, predicting "massive participation."

The yield on Greece's 10-year bond climbed 90 basis points to 9.84 percent yesterday, compared with 9.343 percent on April 30.

Investors may turn to the relative attraction of Asia's bonds because economic expansion in the region means sovereign balance sheets are stronger, according to Standard & Poor's. "The growth story and sovereign-balance story in Asia looks relatively better, much better in some cases," William Hess, director of sovereign ratings for S&P in Asia, said in an interview this week in Tashkent, Uzbekistan.

This is reminiscent of HPA (perpetual housing price appreciation) that was used in the rating agency housing models to justify AAA ratings for junk subprime bond debt. Asia (China and Japan in particular) is in the same NPA/debt boat as Europe and the US. China has simply super-stimulated their economy and we are are awaiting the results of massive bubble blowing. Reference:

More than 51 percent of Greeks said they won't accept new austerity measures before the rescue deal, according to a poll of 1,000 people by ALCO for Proto Thema newspaper. That compared with 33 percent who would accept them. No margin of error was given for the poll conducted from April 27 to April 29.

Union Record

Unions have had some success influencing policy in the past. They forced then-Prime Minister Costas Simitis to dilute proposals such as raising the retirement age in 2001. Unions successfully opposed a government proposal in 1985 to cut spending and boost tax revenue, prompting Simitis, who was economy minister at the time, to resign two years later.

This is the reason why a simple extrapolation of foreign claims against and withing the PIIGS will fail to tell you who's next after Greece. While an examination of foreign claims reveals a lot, it fails to tell the whole story.

Foreign Claims against 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 breakdown of the total exposure as well as the level of risk surrounding each component. These components include a) government default b) private sector default and 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. Hence, the origin of our Sovereign Contagion model (Sovereign Contagion Model - Retail and Sovereign Contagion Model - Pro & Institutional) 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.And not, back to the article...

Some economists say the terms are too harsh for the country to bear. Greece expects its economy to shrink 4 percent this year and 2.6 percent in 2011.

"The economic pain that such belt tightening will bring suggests that it would be unwise to rule out a default further down the line," Ben May, an economist at Capital Economics in London, said in a note.

The danger for the euro region is that failure to end the Greece crisis after three months of wrangling by EU leaders will prompt investors to shift attention to the deficits of Portugal and Spain, and dump their bonds too. Spain's budget gap was the area's third highest last year, at 11.2 percent of GDP. Portugal's shortfall was fourth at 9.4 percent of output.

Follow my ongoing analysis of the Sovereign Debt Crisis, now over 30 articles strong and available to the public.

Latest Pan-European Sovereign Risk Subscription Research - The Good Stuff!!!

Actionable Intelligence Note For All Paying Subscribers on European Bank Research
A Review of the Spanish Banks from a Sovereign Risk Perspective - retail.pdf
A Review of the Spanish Banks from a Sovereign Risk Perspective - professional
Ireland public finances projections
Spain public finances projections_033010
UK Public Finances March 2010
public finances projection
Greece Public Finances Projections
Banks exposed to Central and Eastern Europe
Greek Banking Fundamental Tear Sheet
Italian Banking Macro-Fundamental Discussion Note
Spanish Banking Macro Discussion Note

 

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