Showing posts with label leverage. Show all posts
Showing posts with label leverage. Show all posts
March 25, 2012
Italy Exposure to Derivatives
It was nothing more than a footnote in the Morgan Stanley financials; a $3.4 billion pay-out by Italy to settle a derivatives contract made in 1994. Say goodbye to 50% of the tax hikes imposed by the Monti government because that is what was wiped out by this payment. It is also interesting to note that that Mario Draghi, currently President of the European Central Bank, was the Director-General of the Italian Treasury when this derivative was formulated. Then comes the bomb, only mentioned in a brief article on Bloomberg, and not noted anywhere in the Press. Marco Rossi Doria, an undersecretary in Monti’s administration, tasked with responding to a parliamentary interrogation on derivatives, admitted that the Italian Treasury had $211 billion in "notional" exposure to derivatives, which is around eleven percent (11%) of Italy’s total GDP. This new exposure now brings Italy’s actual debt to GDP ratio to a whopping 144.3%.
Expect further corrections of Monti's government in the following months, the ransack of Italy to cover derivatives contracts is likely to continue for years.
Eurozone Unsustainable Debt could bring Germany to leave the Euro
Eurozone crisis can has been temporarily frozen by the ECB but is on track to come back home with a revenge. There are many signs that the ECB intervention could have actually made things worst in exchange for some months of relative calm on the markets. Let us not forget that as far back as September 2011, PIMCO’s Co-CIO, Mohamed El-Erian (one of the most connected of the financial elite) noted that French Banks were running REAL leverage levels of almost 100-to-1.
El-Erian said French banks are a particular
cause for concern, noting that "credit markets now put their risk of
default at levels indicative of a BB rating, which is fundamentally
inconsistent with sound banking operations." He adds that bank equity
now trades at a 50% discount to tangible book value on average, while the ratio of market capital to total assets has fallen to 1%-1.5%, compared with 6%-8% for "healthier banks."
The ECB managed to swap out its Greece debt into new debt. But it won’t be able to do this with the remainder of PIIGS’ debts. Instead, the ECB plans on shifting any of the losses from these debts onto the individual EU national banks:
ECB Balance Sheet Jumps Above €3 Trillion
The mix of bond purchases and loans has
exposed the ECB and the 17 national central banks that make up the euro
to losses in the event of defaults or bank failures. Last month, the ECB
was forced to swap its €50 billion Greek bond portfolio for new bonds
to shield the banks from potential losses in the event of any forced
write-downs.
If banks that have borrowed from the ECB
can't pay the money back and the collateral they have posted falls in
value or becomes worthless, the ECB would be on the hook for losses. Most
of these losses would be spread across national central banks according
to their size, meaning Germany's Bundesbank would face the largest
exposure.
Germany is certainly aware of this since it has already put up a firewall that would allow it to walk out of the Euro at any point. Obviously it doesn’t want to, but when the ECB will try to shift the losses from its PIIGS exposure onto Germany’s shoulders, Germany will have no choice. The reality is that the ECB is far too small to cover the astonishing amount of debt a look at the chart below gives an idea of what kind of figures we are talking about.
A solution would be for the ECB to start printing money but it is blocked form doing so from Germany who made clear will walk away from the Euro rather than trigger an hyperinflation.
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