If you are at all wondering why Europe and specifically the PIGS (Portugal, Italy, Greece and Spain) have been in the macro spotlight as the next shoe to drop, it is very helpful to put a framework around the loss possibilities. In the credit markets there are two big issues when trouble arises: 1) How much exposure do you have and 2) How much will you recover if the credit defaults?
Let us frame the whole topic by reflecting on the risk flare that occurred with the default of Dubai. In the case of Dubai, the global exposure to Dubai was $60B. When looking at Greece, the European bank exposure to Greece is $253B. In particular, Germany and France have a combined exposure of $119B.
This might not seem like an astronomical number when reflecting on the hundreds of billions of dollars that the United States has used to bailout our financial system, but Greece is just a starting point. I have pointed it out time and again that if one country is allowed to fail in the Eurozone, then there will be a target painted on the others with weak balance sheets: Portugal, Italy, Spain and even Ireland.
So what does the entire exposure look like? It is not pretty. The exposure for Germany and France to the PIGS is $909B and the exposure for European Banks collectively is $2.1T with a ‘T’.
The reality is that something must be done. I expect there will be a bailout package put in place and that the European Central Bank might get a new charter that is more akin to Uncle Sam’s. Can you hear the printing presses ramping up? The Euro will most likely feel downward pressure in months to come and the efficacy of the Eurozone will be left as a big question mark for a future debate.
Disclosure: Short Euro