Debt Bomb


All you can still do now is to try and get out of the way of that snowball that’s headed in your direction. Get out of debt. Think about your basic needs.

Ilargi: The saying of course says “kicking the can down the road”, and we see it used a lot when referring to the financial crisis and the reactions to that crisis from governments and central banks. It’s a pretty good metaphor as metaphors go, but I don’t think it’s perfect; it doesn’t paint the whole picture. A can that gets kicked doesn’t change much. The financial crisis does change, however; it gets bigger as we go along. A snowball fits that picture much better. Fits the present weather better too. And at a certain point that snowball will get so big, nobody’s strong enough to kick it any further.

A good illustration is provided by a series of numbers regarding Ireland, and the eurozone in general. As Finnish commenter Latturi said at The Automatic Earth yesterday:

It seems to me PIGS-countries have morphed into BIGPIGS-countries.

  • Belgium
  • Ireland
  • Greece
  • Portugal
  • Italy
  • Great Britain
  • Spain

That sounds about right. Except that we have seen Austria mentioned as a potential problem case as well. Time for an anagram app?!

Ireland debt was cut 5 levels in one fell swoop by Moody’s this week. Belgium and Austria are rumored to be the next in line for downgrades and then bail-outs. But for now we can focus on the big four problem cases: Greece, Ireland, Portugal and Spain. The last two deny any problems exist in their economies, while Greece saw a once popular politician stoned by protesters. We can but await in fear for what is to follow across the entire region.

By combining some data the picture gets pretty clear. First, Harry Wilson at the Daily Telegraph writes this:

Lloyds writes off half of Irish loans

Lloyds Banking Group and Royal Bank of Scotland shares tumbled on Friday after Lloyds said it had effectively written-off more than half of its outstanding loans to Irish borrowers. Lloyds shares closed down 3.6pc at 66.5p, while RBS’s fell 5.7pc to 37.82p as the market took in the impact of the new write-downs.

In a statement, Lloyds said it had seen a “further significant deterioration in market conditions” in Ireland and that a further 10% of its £26.7bn portfolio of Irish loans would be impaired by the end of the year. “We are concerned that any economic recovery in the Republic of Ireland may take longer to achieve, and that asset prices will remain depressed for longer than previously anticipated,” said Lloyds.

Provisions to take account of the worsening in the portfolio will amount to an additional £4.3bn this year and total provisions now cover about 54pc of the entire loan book, effectively meaning Lloyds does not expect to get back at least half of its Irish loans. The huge write-offs have largely been driven by the collapse of the Irish property market and 90% of the bank’s loans against commercial property in Ireland are impaired, meaning that the borrower is either behind on payments or unable to service the debt.

Ilargi: Then both Mike ‘Mish’ Shedlock and John Mauldin address a new report by the Bank for International Settlements (BIS), which has some revealing stats concerning international banking exposure to the European problem children. Here’s Mauldin first:

HOORAY! Europe Just Kicked The Can Down The Road

The PIIGS collectively owe over $2 trillion to European and US banks. German, French, British, Dutch, and Spanish banks are owed some $1.5 trillion of that by Portugal, Ireland, Spain, and Greece by the end of June, 2010. That figure is down some $400 billion so far this year, which means that the ECB is taking on that debt, helping banks push it off their balance sheets.[..]

Robert Lenzner notes something very interesting about the latest BIS report, out this week:

“What’s curious, though, is that for the first time the BIS has broken out a new debt category termed ‘other exposures’, which it defines as ‘other exposures consist of the positive market value of derivative contracts, guarantees extended and credit commitments.’ These ‘other exposures’ – quite clearly meant to be abstruse – amount to $668 billion of the $2 trillion in loans to the PIIGS. “So, bank analysts everywhere; you now have to cope with evaluating derivative contracts that could expose lenders to losses on sovereign debt. Be on notice!”

What did I write just last week? That it is derivative exposure to European banks that is a very major concern for the world and the US in particular. It is not just a European problem.[..]

A collapse of a major European bank could trigger all sorts of counterparty mayhem in the US banking system, at least among our major investment banks. And then people would want to know which bank was next. This is yet another reason why the recent financial-system reform was not real reform.

We still have investment banks committing bank capital to derivatives trading overseen by regulators who don’t really understand the risk. Who knew that AIG was a counterparty risk until it was? Lehman was solid only a month before until it evaporated. On paper, I am sure that every one of our banks is solid – good as gold – because they have their risks balanced with counterparties all over the globe and they have their models to show why you should go back to sleep.[..]

At first, the political types came up with the stabilization pact in conjunction with the IMF. But this was never a real solution, other than for the immediate case of Greece … and then Ireland. It has some real problems associated with it. It could deal with Portugal but is clearly not large enough for Spain. It is worth nothing that the political leaders of both the latter countries have loudly denied they need any help. Hmm. I seem to remember the same vows just the week before Ireland decided to take the money.

One of my favorite writers, Michael Pettis penned this note:

“Its official – Spain and Portugal will need to be bailed out soon. How do I know? In one of my favorite TV shows, Yes Minister, the all-knowing civil servant Sir Humphrey explains to cabinet minister Jim Hacker that you can never be certain that something will happen until the government denies it.”

Ilargi: And then a Bank for International Settlements graph that Mish posted:

Ilargi: So let’s play with the numbers a little, shall we?

Lloyds Banking Group has so far written down 54% of its Irish loans. Let’s assume their portfolio is not much different from other financial institutions, and that these will therefore have to do the same at some point in the future. At the 54% rate that Lloyds has written down so far – and note that they already announce a further 10% loss, and 90% of their commercial real estate loans are impaired -, we can quite easily estimate what’s in store for other international banks with exposure to Ireland.

That is to say, US banks’ losses in Ireland, at the 54% write-off rate, would be $58.5 billion, while German banks would lose $100.7 billion and British counterparts $101.25 billion.

And these are all numbers that, as far as we’ve seen, have not been entered into account to date. Lloyds may have opened a Pandora’s box, though, or a snake pit if you will, and really, why on earth Citigroup shares rose 2.47% on Friday, in that climate, with this information, is beyond me. Or is that because former Obama Budget Director Peter Orszag now works at Citi, providing a direct bail-out line?

A $58.5 billion loss for the main Wall Street banks may seem doable; the German and British losses certainly do not. And Ireland is just the tip of the iceberg (or the snowball). At that same 54% write-off rate, banks’ exposure to Spanish debt works out as follows: Germany – $116.9 billion, France – $108.5 billion, Great Britain – $73.7 billion, US – $93.3 billion.

If we add Portuguese and Greek debt to the mix, and we look at total exposure to the four biggest EU problem cases, and potential losses from it, we see that German banks’ exposure totals $512.7 billion, and losses at 54% write-offs $276.8 billion, French banks’ exposure totals $410.2 billion, with losses at 54% write-offs $221.5 billion, British’ banks exposure totals $370 billion, losses at 54% write-offs $199.8 billion, US banks’ exposure total $352.9 billion, with losses at 54% write-offs $190.6 billion.

Is there anyone out there who wishes to claim that German banks can absorb $276.8 billion in losses, French banks $221.5 billion, and British $199.8 billion, and still the whole shebang can live happily ever after? If there is, please let us know who you think lives at the North Pole.

Total global exposure to Ireland, Portugal, Spain and Greece is $2.281 trillion. A 54% write-off would mean a $1.23 trillion loss for the international banking system. And that’s for the exposure to the debt of just four countries, which have a total population of no more than 75 millon people! Let that sink in! And let’s not forget the timeframe, either: as quoted above from the Telegraph: “German, French, British, Dutch, and Spanish banks are owed some $1.5 trillion [of that] by Portugal, Ireland, Spain, and Greece by the end of June, 2010“. Also, once again, keep in mind that Lloyds already sees a further 10% downgrade before the end of 2010 (!!), and dark prospects going forward.

Now, we could argue that the losses on Ireland debt will turn out to be the worst of all countries involved. But we might have a hard time making that case, even if the ECB, Spain, Germany and the US Federal Reserve are hell bent on kicking that snowball as far as they can.

Thing is, that snowball will become too vast to be kicked even another inch.

And frankly, I don’t see why write-downs on Ireland would have to be so much worse than those on Spain or Portugal. Look for instance at this “funny” map of Irish ghost estates:

Ilargi: And then compare that with this story by Suzanne Daley and Raphael Minder in the New York Times:

Newly Built Ghost Towns Haunt Banks in Spain

The boom and bust of Spain’s property sector is astonishing. Over a decade, land prices rose about 500 percent and developers built hundreds of thousands of units — about 800,000 in 2007 alone. Developments sprang up on the outskirts of cities ready to welcome many of the four million immigrants who had settled in Spain, many employed in construction.

At the same time, coastal villages were transformed into major residential areas for vacationing Spaniards and retired, sun-seeking northern Europeans. At its peak, the construction sector accounted for 12 percent of Spain’s gross domestic product, double the level in Britain or France. But almost overnight, the market disappeared. Many immigrants went home. The national unemployment rate shot up to 20 percent. And the northern Europeans stopped buying, too. But government officials now say the worst is over, with housing prices down a modest 12.8 percent from the peak, according to the Bank of Spain.

“Most of the adjustment in housing prices has already taken place,” José Manuel Campa, Spain’s deputy finance minister, said recently, though he allowed that there was a lack of good information on real estate sales. Still, skeptics abound.

One is Jesús Encinar, the founder of Spain’s most popular property Web site, He says that the Spanish authorities are striving to engineer a soft landing of the housing market that would give more time to offload surplus housing at reasonable prices. But he believes prices still have a long way to fall, by 30 or 40 percent, maybe more. “Some people who said there was no housing bubble are now saying we are at the bottom,” Mr. Encinar said. “But I say we have several years to go.”

He is not alone in scoffing at some of Spain’s numbers. In a report last April, the French bank Société Générale dismissed many of the assertions made by Spain’s banks, pointing out that Spain had one of the fastest rates of expansion in construction, had the largest number of mortgages per capita and was the most overbuilt among its peers. Yet prices had fallen the least. “We find it impossible to reconcile the banks’ claims of asset quality stability and the macro facts,” the report said.

There is also little agreement even on the number of housing units for sale. José Manuel Galindo, president of Madrid’s association of real estate developers, noted that one of Spain’s leading property appraisers, Tinsa, recently estimated that there were 10,000 unsold housing units around Spain’s capital city. Government figures, however, put the figure as high as 50,000 units, he said. “What is amazing to me is that nobody is investing in doing a very thorough and reliable study of what is the exact supply and demand,” Mr. Galindo said.

Ilargi: Ehhh, no, as I said, I don’t see a good case for claiming that Spain is in any better shape than Ireland is. Or Portugal, for that matter. When Stoneleigh and I were in Basque country in northern Spain last week, we heard people ask how it was possible that Spaniards buy €300.000 apartments on a €1000 monthly salary. When I was in Portugal 10 years ago, people were already taking out mortgages that could by default only be characterized as multi-generational, since they were clearly impossible to pay off in one lifetime with their incomes.

There’s a lot more pain to come in the European periphery. Think Italy. Romania, Hungary, Baltics. And then it will spread to the core, France, Holland, Germany. Still, rest assured that all politicians and bankers and brokers and financiers will keep on kicking that snowball down the road. Until they can’t. Until it’s become a snow mountain. That you will be trapped in.

And if you feel smug about being in the US when you read things like this about Europe, don’t. Just don’t. What will happen in Spain will happen in California, and what Ireland goes through, Illinois will. This is a global crisis, not a local one. And no, this particular time is not different, and neither is your particular location, no matter where you are.

It’s at times as amusing as it is tragic to hear people in Holland or France or Canada or Euskadi (the name the Basque have for their country) argue passionately why they will be better off than others, but it’s no more than Wile E. Coyote frantically kicking his legs around one more time inside the emptiness of nothing but hot air. Every single region will be hit so hard any thought of bragging rights will soon be forgotten.

All those banks, European, American, Canadian, are counterparties to each other’s lost wagers. If one major global bank falls, all will start shaking on their foundations. They will have taken all of their countrymen’s money by then, though. And it’s already too late to prevent that from happening. All you can still do now is to try and get out of the way of that snowball that’s headed in your direction. Get out of debt. Think about your basic needs.

It’s all really simple from here on in. As simple as it is sad.

Happy holidays to you and yours from The Automatic Earth.

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