Europe’s TARP

Part of the gloom sitting over the U.S. markets has to do with the uncertainty surrounding the fate of the world’s banking system should any of the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) default on their sovereign debt.  The European Central Bank’s (ECB) recent action to “save” Greece really wasn’t undertaken for the sake of Greece.  Rather, like the saving of AIG in 2008 by the Treasury via TARP, which was, in fact, a move to save Wall Street’s “Too Big To Fail” from the domino effect that would have resulted from their large counterparty exposure to each other, so too, the ECB’s bailout plan was done to protect the European banking system, especially Germany, the Netherlands, Belgium, and France.

In April, the Bank for International Settlements published a study showing the percentage of bank assets exposed to the sovereign debt of the PIIGS by country.  Canada, Chile, Panama, and Mexico had zero exposure.  The exposure of other major economies is shown below.  The first set of exposures appear to be minimal, with total banking exposure not a threat to the financial systems:

Australia: .08%;  Brazil: .198%; U.S.: 1.57%

The following exposures would imply that the country’s banking capital may be exposed:

U.K: 4.53%;  Austria: 4.84%;  Japan: 5.02%;  Germany: 6.18%;  Netherlands: 6.79%;  Belgium: 7.93%

Finally, these three appear to have significant issues if there is a sovereign default:

France: 10.40%;  Ireland: 13.50%;  Portugal: 14.08%

Several conclusions jump out from this data:

• A default in any one of the PIIGS would likely cause the Irish or Portuguese banking system to collapse, and maybe even that of France.  This may have a domino effect on those systems with 4.5%+ exposures; thus, the logic for the ECB’s recent actions;
• The Americas, both North and South, and Australia have little exposure and, besides stock market unease, are unlikely to have systemic banking risk as a result of a PIIGS sovereign default.

Individual bank data dealing directly with this issue is harder to come by as most banking systems still resist transparency.  Rochdale’s Richard Bove, in early May, tried to segregate loans by dollar value by major U.S. banks to the PIIGS by country.  His data, however, include both loans to sovereign governments and to the private sector.  Nevertheless, an examination of his data can lead to some conclusions about such exposure.  The table below shows five “Too Big To Fail” Wall Street institutions.  I have taken Bove’s data by country and aggregated it to the PIIGS as a whole. In addition, I show the data as a percentage of the institutions’ leverage capital.  That gives us an idea of how exposed the capital is to events in the PIIGS countries.

JPMorganChase (JPM) has the most direct exposure; the rest appear safe.  Remember, even in a default, the public sector debt is still worth something; no one expects the private sector loans to have a default rate even approaching 10% of exposure. (In a separate revelation, BankAmerica (BAC) has indicated a $193 million exposure to Greek sovereign debt and $1.1 billion to the Greek private sector.  Still, total exposure is less than .9% of capital.  Because of the small amount, Bove did not capture this in his analysis – once again speaking to the transparency issue.)  The real danger in the European theater arises if the contagion spreads to France, Germany, and the U.K., which all have significant exposures in their banking system as I indicated earlier. As you can see from the table above, everybody’s exposure, except apparently BankAmerica (BAC), would become quite significant.  Thus, the Fed’s recent actions to provide greenbacks to its European friends now makes sense.

As for the European major banks, HSBC (HBC), Credit Suisse (CS), and UBS (UBS) claim that they have little to no exposure to PIIGS sovereign debt.  My research shows that the three most exposed banks in Europe are Commerzbank (CBK.XE) of Germany with 88% of its capital exposed, Unicredit (UCG.MI) of Italy with 57% exposure, and Banco Santander (STD), with 55% exposure most of which is to Spain’s public debt (its home country).

Like the failure of the Bear hedge fund in July ’07, the Greek issue appears to be the canary in the coal mine.  And, like the actions of the U.S. Treasury, the Fed, and with delay, the Congress to shore up the financial system via the TARP, the ECB, after some months of delay, has followed suit.  There is more of this drama left to play out, and markets will show volatility along the way.

Robert Barone, Ph.D.

May 17, 2010