Events are unfolding more dramatically in Europe this week, a systemic unraveling not unlike what we witnessed in 2008 with the collapse of Lehman here in the States. Greece is teetering on the default line, French banks are being threatened with downgrading for their bond exposure to Greek bonds, the US economy wobbles on the line of recurrent recession and the question remains what will happen if the Eurozone collapses altogether It is a sticky wicket to be sure. Black swans squawk in the near distance, storm clouds gather at the horizon. The complexity of it all is anything but simple.
Others here are much more skilled and knowledgeable in finance and economics than I, but I do try to follow as a layperson and thought I’d share some of the tools I have found on line to keep track of the credit default spreads (CDS’s) on the most at risk European nations. They are looking really bad this week. I hope others will contribute their expertise on what we might be seeing happen with Europe in the coming days.
More graphs, links, and thoughts below
Kossack gjohnsit started a discussion on the subject over the weekend, World financial leaders brace themselves for the next Big Crisis and earlier this morning, Something the Dog Said, put up a post, Markets in Europe Plunge Over Greek Default Fears.
The New York Times also had a good article this morning, Markets Brace as the Crisis in Europe Flares Up Again
On Greece -
Fears about Europe’s deteriorating finances intensified on Sunday as new doubts about the health of French banks, as well as Germany’s willingness to help Greece avert default, left investors bracing for another global stock market downturn this week.
In Greece, the epicenter of the Continent’s financial disarray, government officials announced new austerity measures on Sunday, even as the country’s finance minister, Evangelos Venizelos, warned that the Greek economy was expected to shrink much more sharply this year than previously anticipated. In a revision, a contraction of 5.3 percent in 2011 was predicted, rather than the 3.8 percent forecast in May.
The Greek government has responded by more austerity measures and by raising taxes on everyone’s electrical bills. Meanwhile, Greece will run out of cash in the middle of October.
The Greek government announced on Sunday a new property tax to make sure it will comply with the terms and qualify for the tranche. The EU's Commissioner for Monetary Affairs, Olli Rehn, welcomed the move, saying it went "a long way" toward meeting the country's targets.
But workers at power utility PPC reacted angrily, vowing to block the tax, which the government plans to collect through electricity bills to make sure citizens will pay quickly.
And for a Greek perspective, read here: Germany doesn’t exclude “orderly default” for Greece
On the French banks -
On Sunday, French government officials braced for possible ratings downgrades by Moody’s Investors Service of France’s three largest banks, BNP Paribas, Société Générale and Crédit Agricole, whose shares were among the biggest losers last week. The biggest banks in Europe, especially in France, hold billions of euros’ worth of Greek bonds, and investors fear even a partial default by Greece would sharply diminish the value of those assets, eroding already weak capital positions.
American financial institutions, typically heavy lenders to their French counterparts, have begun to pull back on these loans, but United States banks’ exposure to France remains substantial.
More on that in this article:
French banks may face Moody's downgrade
Here are a series of images captured from Bloomberg charts of the Credit Default Spreads for several of the vulnerable European nations to give you a sense of the extremes they have attained, particularly Greece.
And here is a chart I made of the CDS’s of these countries plus a few extra, including Poland, because we shouldn’t forget Poland, ever. : )
I made that chart using the tools provided by Deutsche Bank AG Tool for generating charts, which is based on the data supplied by Bloomberg.
Here’s a bit of useful information on CDS’s from DB
Why looking at the CDS market is interesting
• A Credit Default Swap (CDS) insures against losses stemming from a credit event. In the context of countries, the contract protects against the default of the issuing sovereign. The premium (spread) which the protection buyer (e.g. a bank) pays to the protection seller (e.g. an insurance company) is determined by market forces and depends on the expected default risk of the respective country.
• Therefore, CDS spreads are an indicator of the market's current perception of sovereign risk. Notice though that CDS spreads also depend on other factors such as market liquidity, counterparty risk and the global financial environment, in particular US interest rates and global risk appetite.
• DB Research translates CDS spreads into implicit default probabilities online so that they can be interpreted in a straightforward manner: for example, a spread of 200 basis points is equivalent to the notion that the market is pricing in an annual chance of about 3% that the issuing government will default.
• Notice that one has to make an assumption about the expected recovery rate for such computations - in the example, we used a 40% recovery rate which is the market convention for the quotation of many CDS contracts. In the online application, the recovery rate assumption can be varied by the user. Also note that the higher the assumption about the recovery rate, the higher the implicit default probability.
Other links for more info:
What Do Rising Sovereign Credit Default Swaps Mean?
Default Risk.com: Academic papers and other useful sources dealing with credit, risk and default.
This paper is particularly relevant to this issue: The Relationship Between Credit Default Swap Spreads, Bond Yields, and Credit Rating Announcements by John Hull of the University of Toronto,Mirela Predescu of the University of Toronto, and
Alan White of the University of Toronto
Transparency .org: A site dedicated to uncovering corruption, globally, which I believe is highly relevant to the underlying root cause of this debacle.
This diary is dedicated to the people of Greece and Loukanikos, the revolutionary Wonder Dog