France is next

While I was on holiday over the last week I spent some time musing over the current situation in Europe and just how bad I think it can get. I have been wondering for quite a while when France will finally join the PIIGS camp, given that it to is a highly indebted nation with insipid GDP.

I have posted a number of articles over the past months about the fact that Europe will eventually have to face up to a sovereign debt crisis because nothing is being done to address the fundamental issues within Europe. Something I note the ECB’s policy maker made quite clear over the weekend.

Cutting Greece’s debt will not solve the country’s problems, ECB policymaker Jens Weidmann was quoted as saying on Sunday, adding Athens needed to raise its productivity instead.

“Greece consumes considerably more than it produces, the public budget shows high deficits,” Weidmann, head of Germany’s Bundesbank and who sits on the European Central Bank’s Governing Council, was quoted as saying.

“As long as that doesn’t change, a hair cut will not really improve anything,” he said, Bild am Sonntag newspaper reported.

Euro zone policymakers are exploring ways to extend a rescue deal for overborrowed Greece and give it more time to repair its public finances. At the same time, authorities are trying to prevent the debt crisis from escalating in the bloc’s periphery.

On Saturday, German magazine Der Spiegel reported — citing unnamed German finance ministry sources — Greece could cut its public debt by 20 billion euros ($28.2 billion) if it bought back sovereign bonds at market prices as part of a rescue.

The finance ministry declined to comment.

Wolfgang Franz, head of Germany’s “wise men” economic advisers, told Focus magazine on the weekend a hair cut was “inevitable and justified.”

“One possibility would be that the current EFSF euro rescue mechanism swaps — at a significant discount — Greek bonds into bonds it issues and guarantees,” Franz was quoted as saying.

The ECB has signaled it remains fiercely opposed to any form of default. The bank is fearful the problems that have hurt Greece, Ireland and Portugal could spread to other indebted euro zone members if a default were triggered.

The European emergency fund purchasing bonds in the secondary market is just another step towards an actual monetary union. Something the ECB’s Lorenzo Bini Smaghi is obviously pushing for.

The European Central Bank renewed its call for politicians to empower Europe’s rescue fund to buy government bonds on the secondary market.

ECB Executive Board member Lorenzo Bini Smaghi said in an interview with Greece’s To Vima newspaper that it would be “useful” to allow the European Financial Stability Facility to buy bonds on the open market, according to a transcript published by the Frankfurt-based ECB today.

“This would allow the private sector to sell bonds at their market value, which is currently lower than the nominal value,” Bini Smaghi said. “This would allow the private sector to sell while the public sector would save money. Such an option was not included in the design of the EFSF. If there is a way to change the EFSF, that would be useful.”

European leaders in March declined to authorize the EFSF to purchase bonds on the secondary market — a role the ECB assumed last year as the Greek debt crisis escalated. Bini Smaghi said the onus remains on Greece to pursue its fiscal consolidation program. He also encouraged Greek banks to sell foreign assets.

“The Greek banks have to sell some assets abroad, get fresh money in the system to be able to contribute to the recovery, do mergers even with foreign banks to bring foreign capital,” he said. “If you consider the fully hypothetical situation in which all Greek banks were owned by foreign capital, as was the case in eastern Europe, then a lot of problems in Greece would be eased.”

There is an assumption in that last statement that foreign banks are in some sort of position to expose themselves further to Greece and the other periphery nations. The latest european banks stress test suggests otherwise as noted by the Wall Street Journal:

Banks tend to be holding far greater quantities of those commercial and retail loans than they are of sovereign debt, according to a Wall Street Journal analysis of disclosures accompanying the stress tests.

This year’s stress tests represent the first time there has been a uniform way to measure this exposure. Until now, banks have disclosed their portfolios of loans to customers in troubled countries on a piecemeal basis. That made it virtually impossible to aggregate data across the industry or to compare different institutions.

“The country-by-country exposure [data] is better than any data we’ve seen before,” said Alastair Ryan, a London-based banking analyst with UBS AG. “It’s giving me more things to be fearful of,” Mr. Ryan added, referring to the disclosures of some banks’ large holdings of loans to customers in troubled countries.

After Spanish and Italian banks, France’s banks appear to be the most exposed. As of Dec. 31, its four largest banks—BNP Paribas SA, Crédit Agricole SA, BPCE Group and Société Générale SA—were holding a total of nearly €300 billion, or about $425 billion, in loans and other debt issued to institutions and individuals in Portugal, Ireland, Italy, Greece and Spain, the countries that are among Europe’s most troubled. That is largely a result of some of the French banks having big retail- and commercial-banking operations in Greece, Italy and Spain.

The French banks’ portfolios of commercial and retail loans in those countries dwarf their holdings of sovereign debt.

It needs to be remembered that these are countries that have suffered substantial property market shocks and there will be substantial unrealised losses across all of these balance sheets. A quick glance at European bank exposure to the PIIGS should ring alarm bells across the board:

Spanish exposure to itself and other periphery nations is massive. A translation of an article on a Cotizalia a Spanish language website explains just how big the problem is:

With that comes over to the Spanish banks in coming quarters, rising delinquencies, loss of use of its vast real estate assets, reduced margins, loss of turnover, so the open bar ECB’s liquidity, .- etc, the only front that seemed to have solved was that of the wholesale funding by improving markets and emissions with a State guarantee. Now, what entities have not solve the problem, but put it off a few years. Because, although covered with maturities of 2009 (about 80,000 million euros), will face renewed another 240,000 over the next three years.

This is reflected in a report published yesterday by the rating agency Moody’s, which estimates that banks and Spanish will have to cope with maturities of 75.884 million next year, from 63.272 million in 2011 and no less than 100.487 million in 2012 which will be the year more complicated. This is because that is when the bulk of emissions overcome with a State guarantee made ​​in 2009, whose term is three years (although recently Caixa Catalunya , Bancaja and CAM have been issued to five).

Translation: If you thought 2011 was a problem for Europe, just wait for next year.

With Greece dead, Spain completed overloaded with debt, Portugal now at junk status, Italy on the suicide radar it is only a matter of time before France joins in. You can see from the above chart that French banks are third in line on the debt hook, yet they still seem to be flying under most radars. A quick glance at French fundamentals tells you they are in a similar position as the Portugal, Italy, Greece and Spain.  High debt in both the public and private sectors, trade imbalance that continues to grow and a current account that has been in the red for years.

Once the markets realise that it is actually the F-PIIGS then the ECB will have no choice but to back flip on every single prudent banking rule and the floodgates for a Euro QE program will open. Nothing is being fixed and the news just gets worse by the day.

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    • MontagueCapulet

      France is next. But the logical endpoint is to worry about Germany. They are fiscally sound compared to their neighbours. But their government debt is 78% of GDP, they are running a 3%deficit, their banks are in trouble, and half of Europe expects Germany to bail them out.

      A few more years of 3% deficits and a couple more bailouts and Germany will be closing in on 100% of GDP government debt themselves.
      What happens when the markets realise that Germany is no longer in fit shape to save anybody?

      • MontagueCapulet

        Also, Germany looks pretty good at the moment because they are able to export high-value products to China. If the China construction bubble runs out of steam in a couple of years, you’ll see Germany fall back into recession. I’d say that is likely in 2013-2014.

        This year we worry about Spain. Next year we worry about Italy. In 2013, we worry about France. And by 2014, Germany is back in recession thanks to the China slump, their debt is over 90% of GDP (more if they’ve participated in bailouts) and everyone starts worrying about Germany – which means an existential crisis for the EU.

        Don’t get me wrong, I admire the Germans. No schadenfruede here. The point is that everyone else in the EU is counting on the Germans to bail them out. It’s the unquestioned assumption in the room, like the idea that China will keep growing for decades. When the strongest stumble, how will the weak fare?

  1. Great analysis DE.

    Kinda punctuates why Central banks have bought more gold in the first half of this year than in all of 2010 due to these lingering economic uncertainties.

    IMO the momentum in CB gold holdings will keep increasing as a structural shift in reserve asset management.

  2. If France follows, then the UK, Netherlands and Germany does that mean we’ll have FUKING PIGS?

  3. I am having trouble keeping my breakfast down after reading that.

    DE I think you should ony post these shockers mid morning or afternoon.

    I had always been hopeful there was a way out for us all but if/when the major Euro powers go bankrupt as that is the end game for all this. The sufferring and human misery in Australia will be severe.
    If anyone has any ideas on what type of employment may survive this Tempest suggestions would be appreciated.

  4. F-PIIGS – bahhhhhh…
    Now we only need to get Kosovo and Norway to have problems and we end up with


    That one statement really sums it up…

    Sorry if that offended anybody 🙂

  5. MontagueCapulet

    If France bails out their banks, their debt will hit 100% of GDP.
    If Germany bails out France, its debt will hit 100% of GDP.
    If Germany runs a 3% deficit for another 7 years then by 2018 it will have a debt of 100% of GDP on its own. If it participates in any further bailouts it will get their earlier, probably by 2015.
    So the end game is that by 2015 everyone, even Germany, is up to 100% of GDP in debt. At this stage who is left to buy their bonds? Either the Fed prints money to do it, or China prints money to do it, or the ECB starts engaging in QE themselves.
    What happens when the USA, EU, Japan and China are all funding their defits via QE at the same time? You’d expect some inflation. But I think given the deflationary pressures at the moment, they can print for a few years before inflation happens.

    • Yes, Yes and Yes to your 3 comments. You could go even further and look at the productive parts of Germany (the productive belt in the South to the West) of around 30 million people carrying 80 million Germans. And extrapolate from there.
      I would also argue to include the off-balance-sheet stuff into debt figures. There is some stuff from 1990 onward not consolidated in most debt figures (Deutsche Einheit). Then you have over 800 billion Euros of bad debt in Bad Banks (not to mention the “Good” ones). A 50 % recovery brings us up 400 billion Euros. Or you put it in the P&L of Germany. It normally takes our banks 10 years to lose 500 bn, or 50 bn a year – then we are already at 4,5% budget deficit. Only problem is with European bailouts this figure is going up dramatically. I would not wait until 2015 with the endgame.
      Autumn 2013 already looks interesting.

  6. An insatiable appetite for consumption funded by debt, combined with poor productivity is a sure recipe for financial armageddon. These countries finances are beyond a mess, and the world will surely stabilise much quicker if they all vomit out the muck and get it over with, rather than trying to take an aspirin and hoping it all just goes away.