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Introducing The BoomBustBlog Sovereign Contagion Model

Thus far, it has been right on the money for 5 months straight!

Anybody who has been following for the last fiscal quarter or so (or has seen my Spanish bank work in 2009) knows that I believe that the EMU as it stood in 2009 would probably be non-existent by the end of 2010. All of the pundits who proclaimed that the European debt crisis was over with the mere declaration that Greece may receive some additional debt either were abjectly lying or truly didn't understand the gravity of the situation. To be honest, there are a lot (and I mean a whole lot) of data points, angles and contingencies to grasp thus it is not necessarily easy. Then again, isn't that what these market professionals get paid for.

Very early in the year, I virtually guaranteed that the Greek banks would fall, or at least have to be rescued (a 2nd time) before they fell. I practically promised it. In the news today...

Lagarde to discuss Greece support with banks: French Finance Minister Christine Lagarde will meet with bank leaders on Wednesday to discuss how its banks could participate in the Greek rescue package. Lagarde told the French parliament the country's banks will reiterate their support for the rescue process on Wednesday but she said tomorrow's meeting could lead to them taking on a more active role, along the lines of what German banks have done. French banks have so far not been asked by the government to participate directly in the Greek rescue package, two sources in France's banking sector said earlier on Tuesday. They have only been asked to maintain their exposure to Greece and have agreed to do this, the sources said. "Nothing beyond this has been requested by the government," one of the sources told Reuters. France has overall the highest exposure to Greek debt, with about $75.2 billion worth of assets in total, according to Bank of International data as at end-2009. Germany's top banks and insurers offered support on Tuesday mainly by keeping open credit lines to banks and by agreeing not to sell Greek bonds for the duration of a wider IMF-led bailout. Germany's Finance Minister Wolfgang Schaeuble said that German financial firms had agreed to buy bonds issued by state controlled bank KfW as a way to help finance the bailout. Deutsche Bank Chief Executive Josef Ackermann said it was important to extinguish the fire in Greece and pledged to help the country. Ackermann is helping to coordinate efforts by the private sector to support the Greek rescue package.

I suggest one references my post, How Greece Killed Its Own Banks!.

The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)...

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

This was quite easy to see coming as those who downloaded the following subscription material can attest:

• Greek Banking Fundamental Tear Sheet
• 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
• Banks exposed to Central and Eastern Europe
• Spanish Banking Macro Discussion Note

This will get much, much worse before it starts to get better. Even those who chose not to pay for the research had plenty of free research to see the path of current events months in advance, they just didn't get the specific banks/securities referenced with fundamental value ranges. Reference:

1. The Coming Pan-European Sovereign Debt Crisis - introduces the crisis and identified it as a pan-European problem, not a localized one.
2. What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect
3. The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. - attempts to illustrate the highly interdependent weaknesses in Europe's sovereign nations can effect even the perceived "stronger" nations.
4. The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries
5. Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?
6. "Greek Crisis Is Over, Region Safe", Prodi Says - I say Liar, Liar, Pants on Fire!

Here are some more MSM news clips that drive the points home:

• European Stocks Erase 2010 Gain on Debt Contagion; Commodities, Euro Fall
• VIX Rises With VStoxx on Concern Debt Crisis to Spread to Portugal, Spain
• Greek Rescue Doubts Spur Rise in Sovereign Default Risk on Contagion Bets
• Is Spain the Next EU Country To Tumble Into a Debt Crisis?: Spain risks falling into the same trap as Greece unless it takes more forceful action, some investors tell the New York Times.

• Report Spain Wants $364 Billion Aid is 'Madness': PM
• Will Investors Avoid Spain's Debt
• ECB May Have to Expand Role

Oh yeah, Spain. This is where our hard core stuff truly comes into play - Spain public finances projections_033010 - real answers to real questions, without the bias and BS.

So, were the opportunities described actionable? Let's take a look...

300% gains on STD June '10 12.5 puts

100% to 150% on the NBG Aug 2.5s

150% to 300% or so on BBVA Oct. 15 puts.

And there's plenty more to go under several different opportunities (subscription only)...

• Actionable Intelligence Note For All Paying Subscribers on European Bank Research - This was certainly one very timely call!!!
• Italian Banking Macro-Fundamental Discussion Note
• and now introducing.....

The BoomBustBlog Sovereign Contagion Model

Nearly every MSM analysts roundup attempts to speculate on who may be next in the contagion. We believe we can provide the road map, and to date we have been quite accurate. Most analysis looks at gross claims between countries, which of course can be very illuminating, but also tends to leave out many salient points and important risks/exposures.

In order to derive more meaningful conclusions about the risk emanating from the cross border exposures, it is essential to closely scrutinize the geographical break down of the total exposure as well as the level of risk surrounding each component. We have therefore developed a Sovereign Contagion model 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.

I. Summary of the methodology

• We have followed a bottom-up approach wherein we have first identified the countries/regions with high financial risk either owing to rising sovereign risk (ballooning government debt and fiscal deficit) or structural issues including remnants from the asset bubble collapse, declining GDP, rising unemployment, current account deficits, etc. For the purpose of our analysis, we have selected PIIGS, CEE, Middle East (UAE and Kuwait), China and closely related countries (Korea and Malaysia), the US and UK as the trigger points of the financial risk dissemination across the analysed developed countries.
• In order to quantify the financial risk emanating in the selected regions (trigger points), we looked into the probability of the risk event happening due to three factors - a) government default b) private sector default 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.
• Foreign claims of the developed countries against the trigger point countries were taken as the relevant exposure. The exposures of each developed country were expressed as % of its respective GDP in order to build a relative scale for inter-country comparison.
• The risk event probability of the trigger point countries was multiplied by the respective exposure of the developed countries to arrive at the total risk weighted exposure of each developed country.

• Sovereign Contagion Model - Retail - contains introduction, methodology summary, and findings
• Sovereign Contagion Model - Pro & Institutional - contains all of the above as well as a very detailed methodology map that explains what went into the model across dozens of countries.

Latest Pan-European Sovereign Risk Non-bank Subscription Research

• Ireland public finances projections_040710
• Spain public finances projections_033010
• UK Public Finances March 2010
• Italy public finances projection
• Greece Public Finances Projections

The Pan-European Sovereign Debt Crisis, to date (free):

1. The Coming Pan-European Sovereign Debt Crisis - introduces the crisis and identified it as a pan-European problem, not a localized one.
2. What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect
3. The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. - attempts to illustrate the highly interdependent weaknesses in Europe's sovereign nations can effect even the perceived "stronger" nations.
4. The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries
5. The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
6. The Beginning of the Endgame is Coming???
7. I Think It's Confirmed, Greece Will Be the First Domino to Fall
8. Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!
9. Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?
10. "Greek Crisis Is Over, Region Safe", Prodi Says - I say Liar, Liar, Pants on Fire!
11. Germany Finally Comes Out and Says, "We're Not Touching Greece" - Well, Sort of...
12. The Greece and the Greek Banks Get the Word "First" Etched on the Side of Their Domino
13. As I Warned Earlier, Latvian Government Collapses Exacerbating Financial Crisis
14. Once You Catch a Few EU Countries "Stretching the Truth", Why Should You Trust the Rest?
15. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!
16. Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe
17. 17. Moody's Follows Suit Behind Our Analysis and Downgrades 4 Greek Banks
18. The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!!
19. How BoomBustBlog Research Intersects with That of the IMF: Greece in the Spotlight
20. Grecian News and its Relevance to My Analysis
21. A Summary and Related Thoughts on the IMF's "Strategies for Fiscal Consolidation in the Post-Crisis
22. Euro-Gossip Debunked, Courtesy of Trichet and the IMF!
23. Greek Soap Opera Update: Back to the Bailout That Was Never Needed?
24. Many Institutions Believe Ireland To Be A Model of Austerity Implementation But the Facts Beg to Differ!
25. As I Explicitly Forwarned, Greece Is Well On Its Way To Default, and Previously Published Numbers Were Waaaayyy Too Optimistic!
26. LTTP (Late to the Party), Euro Style: Goldman Recommends Betting On Contagion Risk In Portuguese, Spanish And Italian Banks 3 Months After BoomBustBlog
27. Beware of the Potential Irish Ponzi Scheme!
28. How Greece Killed Its Own Banks!

 

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