The elephant in the room

We look at the European sovereign debt crisis and benchmark it against theLatin American debt crisis of the 1980’s. We find that this sovereign debtcrisis has at least five dimensions.The first is the cross border exposures to private sector entities, oftenoriginated and funded by the subsidiaries of the largest European banks.Losses from these exposures have been in the region of US$90bn, withUS$50bn of losses in Ireland alone. Further losses from these exposures arebaked into analyst estimates; whether these estimates are conservative or notremains to be seen.The second dimension to the crisis is the sovereign/public sector exposures,which too are often held in the domestic subsidiaries of European banks. Wefind these exposures generally quite modest when measured against thetotality of European bank assets and capital. Certainly, they are dimensionallylower than the exposures of the US money center and European megabanksto Latin America relative to assets and capital in the 1980’s.The third dimension is the ownership by domestic banks in the peripheryeconomies, Spain and Italy, of their own sovereigns’ bonds. Such holdings aretypically 150% to 220% of tangible book value and thus substantial writedownscould trigger recapitalization requirements.The fourth dimension is the potential spillover effects including runs onbanking systems and the negative feedback loop to consumer and businessconfidence that might develop from a disorderly default, which are impossibleto model.The fifth dimension is the possibility of an extreme outcome if the Euro was tobreak up, which again is not something that readily lends itself to companyspecificmodeling.Possibly the most desirable scenario, but not necessarily the most likelyoutcome, is provided by the Latin American 1980’s crisis resolution: i.e. a verylong period of uncertainty and significant write downs of private sector debtand then a Brady bond type solution to, and write down of, government debtonce the bank sector can afford it.ΠΠ26/0/2011 DB ReportFiled under: ΕΠΙΚΑΙΡΟΤΗΤΑ