The Greek Canary in the European Coal Mine

Conclusion:  Sovereign debt issues in Europe have not gone away.  In fact, Greek CDS are approaching the highs of June, which we believe are a leading indicator for more issues to emerge on the debt front from Europe.

 

Just when we thought things were settling down in Europe, credit default swaps in at-default-risk nations continue to increase.  In the chart below, we’ve highlighted Greek 5-year CDS.  While we are not quite at the parabolic highs of late June, when insurance for 5-year Greek bonds reached almost 1,150 basis points, we are well off the lows of May.  In fact, CDS are up almost 50% from their lows this summer.  Interestingly, the lows were put in literally the day the EU bank test results were released. 

 

The Greek Canary in the European Coal Mine - 1

 

Back in March 2010 in our theme presentation entitled, “Where Does the Sovereign Debt Cycle End?”, we highlighted a few points related to Greece. Specifically, 

  • Greece is typically a leading indicator for defaults in Europe;
  • Debt in Europe is very interconnected, so one nation defaulting could have an impact on the balance sheet of many banks in other nations that hold that debt (we’ve posted a graphic highlighting this at the bottom of the note); and
  • The unreliability of Greek numbers as noted by the fact that in late fall of 2009 they reported their budget deficit was 3.7 percent of GDP and two weeks later that number was revised upward to 12.5 percent. 

The point is, Greek could be worse than we know and there will be a domino effect if Greece unravels.

 

To the lack of understanding the numbers point, the Wall Street Journal wrote an article yesterday criticizing the efficacy of the recent stress tests. The key point from the article was that the stress tests potentially understated the debt levels of many banks.  To highlight this point, we’ve posted a chart from this article directly below. If the analysis is in the ball park of reality, the stress tests missed the mark by a staggering margin. 

 

The Greek Canary in the European Coal Mine - 2 

 

Not surprisingly, the Council for European Banking Supervisors released a statement attempting to rebuke this criticism. The key points from the statement, which defended the tests, are highlighted below: 

  • The “gross exposures” disclosed were on-balance sheet exposures net of impairments but gross of collateral and hedging. 
  • CEBS notes that comparison with other sources should be treated with caution as a result of different reporting dates and reporting methodologies. For instance, data provided by the Bank for International Settlements (BIS), is aggregated in a way which makes comparison with the data disclosed by banks during the CEBS exercise impossible. 

Maybe it’s just me, but with a defense as non-transparent as that, it is really no surprise that the market is once again losing confidence in the at-risk European sovereigns.

 

Chirp, chirp says the Greek Canary.

 

Daryl G. Jones

Managing Director

 

The Web of European Debt

 

The Greek Canary in the European Coal Mine - 3


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