Want an interesting estimate for the cost of fixing peripheral Europe?
Credit Suisse’s Andrew Garthwaite & Co. are here to serve.
They reckon that total bank losses in Spain, Greece, Ireland and Portugal have so far been about €140bn — or 8 per cent of GDP. If you compare those with the same figures for historical banking crises, Credit Suisse estimates peripherals still have about €350bn of additional costs to go through, or 22 per cent of their GDP.
It gets rather worse, however. Look at this leverage chart:
Assuming then, that private sector leverage falls back to the level suggested by income in Spain, Portugal and Ireland (not Greece) — then these three countries would have to reduce their borrowings by €1,300bn, or 80 per cent of GDP.
Again though, if you look at previous banking crises the deleveraging pain looks even worse. In Thailand, Korea, Sweden and Mexico, private sector debt fell by an average of about €1,000bn — or around 60 per cent of their GDP.
Given the above costs then, it’s no surprise that Credit Suisse reckons “some recourse” to the European Financial Stability Facility will probably be required by Ireland, Greece and Portugal. Intriguingly, they think Spain will be alright — at least until its 10-year bond yield goes above 6.5 per cent — at which point the interest burden becomes too high. Spanish 10-year bond yields are currently hovering around 4.5 per cent.
The country is, however, key to whether the peripheral crisis becomes systemic or not:
… We note that countries tend not to restructure until there have a primary budget surplus (as only then does their fiscal arithmetic improve if they default), this gives them a much stronger bargaining position towards creditors. On IMF estimates (Fiscal Monitor, November 2010), Greece will achieve a primary budget surplus only in 2012 – and the rest of the European periphery not until 2015.
We do not think the peripheral European issue becomes a systematic problem for global equities, given that we now have the EFSF mechanism in place. We believe that into even a very bad banking crisis, the write-off costs correspond to around 30% of GDP – and this would amount to €170bn for Ireland, Portugal and Greece. This can be easily be covered by the EFSF, which according to our head of European credit team William Porter can finance up to €250bn – net of fees and guarantees – without IMF and EU help (potentially equal to €250bn and €60bn respectively).
We think the key to the situation is Spain. Spain is key, given that it accounts for 11% of Euro-area GDP (65% larger than Portugal, Ireland and Greece) and that there are $876bn of foreign bank assets in Spain according to the BIS (75% of which are accounted for by European banks, with 40% – around $340bn – held by German and French banks alone). We note that recently CDS spreads have risen to previous peak (with bond spreads not far behind).
However, we suspect the situation in Spain is sustainable – and probably will not need to resort to the EFSF. Even despite the recent rise in bond yields…
And hence, Credit Suisse see no chance of a break-up in the eurozone:
Could core Europe walk away from peripheral Europe? We think the chance of this is zero. The issue is that already core Europe has, on the BIS data, about $700bn of assets in peripheral European debt. Moreover, the ECB holds $71bn of peripheral European government debt directly – and most of the ECB repo financing to European peripheral banks (€322bn, equal to 20% of their GDP) is secured against domestic government bonds. (A third of the cost of recapitalisation the ECB would have to be met by the Bundesbank). This means that – apart from other economic and political issues – there is a huge direct cost for core Europe if there were significant defaults in the periphery. The indirect costs of a failure of the monetary union would be even greater, namely the loss of a single market, with the newly established Deutsche Mark appreciating 20% hitting German exports, the probable erection of trade barriers etc.
Someone call Interpol, we’ve got an EMU hostage situation.
Related links:
A different way of looking at debt – and the developed world - FT Alphaville
Towards a full European economic federation - FT Alphaville