Friday, October 7, 2011

Solving the Eurozone bank problem might not be very expensive


Reader "brodero" points to a website that generates this graph. I can't vouch for its accuracy or completeness, but it tells a pretty interesting—and very optimistic—story about how easy it should be to fix the Eurozone sovereign debt crisis.

The values I've selected above roughly reflect the current prices of PIIGS debt. For example, Greek debt is trading at about 60-65 cents on the dollar; assuming that is a "fair" price, then in a restructuring, debtors could expect to get a "haircut" on their Greek debt holdings of about 64%. The other haircuts I've selected are also in line with current market pricing of each countries' debt. For Ireland, however, I've selected a zero haircut, since I think Ireland is well on the way to emerging from this problem intact, via a very aggressive and successful austerity program. Bottom line, if all PIIGS' debt were restructured in line with current market pricing, then Eurozone banks would need a capital infusion of $135 billion or so in order to remain in compliance with a 7% Tier 1 capital ratio. If the required ratio is 8%, then the additional capital needed would rise to $225 billion. These are big numbers, but $225 billion is less than 2% of Eurozone GDP. That's a drop in the Eurozone GDP bucket, and it shouldn't be too hard to come up with that much money in order to resolve a debt crisis that otherwise threatens to bring down the entire global economy, should it?

If this calculator is accurate, then the only way of understanding why there is so much angst in the markets is to assume that markets are pricing in a cascading series of defaults that become far worse than current market pricing of PIIGS' debt assumes. That's not impossible, of course, but once again we see that the level of fear and pessimism that is impacting market psychology is extreme, to say the least.

19 comments:

brodero said...

What is incredible Societe Generale
which has about 30 billion in Tangible common equity and was trading at a market cap of 35 to 40
billion 6 months ago and now trades
at 15 billion cap...and their hit
for a haircut would be between 3 to 6 billion

Dr William J McKibbin said...

A default of sovereign debt would certainly be cheaper than the alternative, which would be the aggregate debt principal plus interest and any bailout funding required, all paid for by taxpayers -- the default option needs to be considered...

vbounded said...

Citi's Buiter is calculating 50-80% haircuts on Greek bonds.

Benjamin said...

George Gilder said the wrong response to supply shocks was tight money as that led to deflation in commodities and other markets which led to future "shortages" and long-term inflation. Interesting--the ECB should inflate.

Bill said...

Could it be that these banks have a much larger CDS exposure than we know about and that's why the market is still in a panic?

brodero said...

On September 16th Societe Generale
had 2.96 billion of net CDS exposure...a good portion would
benefit from default...CDS works
both ways but a lot of people do not focus on that...

David K. Waltz said...

I just blogged about this topic as well, though at a much more primal level.

This topic is coming up on two years at this point. Plans have been made, nobody is going to be taken by surprise should Greece default.

Let's start worrying about something else.

Public Library said...

I think the market is worrying about the counterparty exposure should banks get wiped out. Netting works until the banks you net with start dropping like flies.

Dr William J McKibbin said...

My biggest worry -- how to find more money that I can use to buy the equity bargains that are appearing everywhere -- Greece can only make the buyers happier...

Squire said...

Ok. The Euro financial problem gets solved and the European economy doesn't become a drag on the world economy.

The U.S. economy has had its economic recovery from the recession. This is it.

But the structural problems remain. Example: car prices are too high proof of which is that massive amounts of subprime loans are made for cars. They will not only give you 6 years to pay off your loan, they will take the negative equity on your turn-in and add another year to the loan for you. And the government sponors this.

When consumers pull back the economy will contract.

William said...

My biggest worry: McKibbin is extremely bullish ;~)

honestcreditguy said...

Give me a break its Trillions of counter party CDO's and CDS that are embedded in the euro union thanks to the likes of pigmen GS and JPM, Barclays etc...

The smart thing for Greece to do is default..The pigmen need to be held accountable for their crimes against humanity...

Taxpayers have saved them from their stupid decisions enough...

Time is near...the crisis is going be writ large....

keep smoking hopium, it helps but eventually the buzz will wear off and reality is going to step up to the plate and hit a massive homer...no one will cheer when it leaves the ballpark....

TGiF said...
This comment has been removed by the author.
TGiF said...

honestcreditguy,
Today is your lucky day! I just happen to own a mattress store and can cut you a great deal on multiple mattresses that are great for hiding money under. Oh, and I also own a bomb shelter design and construction firm, how big a shelter can design for you for the coming economic apocalypse that you are predicting?
While I agreed that none of the PIIGS' sovereign debt problems should be solved through government bailouts, meaning that there will likely be some defaults, the counter-party issue is overblown because we just wont see the numerous European bank failures that are being predicted - their exposure is just not that large.

Public Library said...

TGIF,

In case you missed the past three years, you can only stuff so much toxic waste on the sovereigns before the market realizes they are just another balance sheet beholden to the laws of physics too.

SlowwwwMotionnnTrainnnnnWreckkkk.

mmanagedaccounts said...

TGIF,
I find intriging your statement about European banks that "their exposure is just not that large." Can you provide some evidence to support that assertion? It would be welcome.

John said...

"My biggest worry -- how to find more money that I can use to buy the equity bargains that are appearing everywhere"

Step right up fellas. "There's a sucker born every minute" (P.T. Barnum).

The economy is out of balance (it's top-heavy), causing it to swing dangerously, like a pinball machine about to tilt.

Game over.

Dr William J McKibbin said...

Bargains everywhere -- more at:

http://wjmc.blogspot.com/2011/10/what-is-bargain.html

We are in a buyer's market big time...

Donny Baseball said...

and surely not every bank on this list needs to be backstopped. Perhaps there are some that a white knight might find attractive and some that the world will not miss at all.