Continuation of greece/bank debt analysis

Couple of weeks ago, my weekend email presented an analysis of the current greek debt and global bank exposure to EU. I  am continuing with that analysis this weekend. As a reference,  the previous  set of facts  are attached at the end of this blog entry.

Market  Commentary:

When it comes to the analysis of current state in EU, the focus of the market is on  4 different fronts.

• Short term:  Will greece get its next tranche of  funding by november ? This is a moot point now, because  last friday at closing market hour, news broke out that greece has been given 8B  euros (explains the closing rally on friday?) For all practical purposes, the november funding has also been assured by EU leaders.
• Intermediate term: The proper leveraging to be applied to EFSF and the resultant amount of money that will be available,  to purchase further  soverign debts of PIGS of europe.  This is being the current point of contention between france and germany.  But today news has broken out that progress has been made at the EU leaders summit. There were already talks of  leveraging  EFSF to over 1T euros.  This assures that the banks will not be squeezed again, like summer 2010, for atleast 6 months more.  This is my gut feeling;  without further research into PIGS, it is hard for me to forecast the exact time duration.   This  intermediate term factor, also ties into the  'bank recapitalization'  factor that is on the  discussion forefront. I will get into this more after ....
• Long term:   EU leaders are working on putting together a grand plan, that addresses various problems (soverign  budgets and auterity measures,  the ultimate amount of funds that maybe needed to save the banks and countries, how much each component  viz. ECB, IMF, banks and countries,  have to contribute to saving of euro,  political and techical restructuring of EU so that a firewall maybe built around greece to protect other countris,... etc).  For now, market is unconcerned about this, imho,  since this pertains to timeframe longer than 6 months.

There is one other point of contention, which is the burden of greek debt that will be placed on banks and other private funds that have bought up greek debt. There is talk of increasing the losses that these private parties have to shoulder (from 21% to near 50%). The banks have opposed this measure 10 days ago, but an increasing is coming. In my opinion, this is irrelavent in the short term to the markets. My logic is simple: as discussed 2 weeks ago, total greek debt = 340B euros. 50% of this = 170B euros, which is to be placed on bank losses.  But there is recapitalization of the banks (through EFSF, ECB loan gurantees for a year, private equity like warren's investment in BAC etc), which would inject much more than this 170B euros, in the short term, into the bank balance sheets.  So, in the short term, this problem disappears, to resurface again, when other parts of EU are in a crisis.

In conclusion, the EU problems have been fixed to an extent that political and financial leaders have  more time to deal with the broader issues like the economic depression that will surface out of this, in europe. In addition one of the other primary drivers i mentioned weeks ago (global economic slowdown), has been postponed into 2012.  So, in the last possible time, they got their act together and risk taking is justified in the eyes of the pros.  In all likelyhood, my initial target for Q4 will be exceeded against this background news, with a potential to reach 1300 emerging.

 Technical  Landscape:

After forecasting the buy at the bottom near 1060-70 ES,  the proper sell area was not
 identified properly in last two weeks. 1180 proved to be only a temporary resistance, resulting in bad calls during last 2 weeks.   At present levels whether you want to buy or sell, depends heavily on your timeframe, given my forecasts for Q4.   Continuing the chart i presented 2 weeks ago comparing 2008 to 2011, i am presenting another comparison this week.(2010 and 2011).

This chart is suggesting that we will top on monday/tuesday and have a pullback after that.   So, i am forecasting this week to reach around 1247 (90% probablity) and the supports are in the vicinity of 1185, 1202 and 1209, should a pullback take place. A proper strategy to trade this plan involves one's  timeframe and risk management criteria. As i post this blog, futures have not opened, and ES close last friday was at 1234.75. I wish you all successful trading week ahead.

(Below is a copy of the email and facts i presented 2 weeks ago, for reference here.)

In this week's  market analysis, i present the research conducted  to nail down the state of  greece debt  and related  issues.   The results were stunning to me, because  i realized  that, if i  had conducted this study  about a month ago, it would have been  of  great help  to us, in  having the proper  fundamental  bias  towards  that range bound market of  last 2 months.  I provide the summary of my research below, in order to avoid  boring you with yet another long email, as many of you wont have time to read even this summary :-)

• I started with a simple question : How  much  exposure the world has to greek debt ?
  business insider.com published an article that shows a study by  BIS (Bank for International Settlements)  and  he exposure of various countries to greek debt.  As of  march, 2011, the total world exposure is 124.7B usd, not counting US and japan, which hold 8.7+1.3 = 10B.  Since  these numbers are about 2 quarters old, i expected the current world  exposure (mostly by european banks),  to greek debt to be higher, which is proved by the next bullet item.
• Next  i asked myself, how much the greeks owe to the world ?  I found out that Total greek debt in bonds = 340B usd. (Sept. 26th reuters). This figure surprised me somewhat, because  it is more than double the  125B that came out from previous bullet item.  Keep in mind that greek banks hold a bunch of  their government debt and some of the debt could be attributed to  big  wealth funds of the world, and other private funds, but still  340B is an aweful lot more than BIS  estimate, back in march.  So, naturally, we have to assume that the current european bank exposure is a lot more than 125B, and quite possibly the banks are not admitting to all of their exposure.  
• The above two facts clarified a lot of things, because i already knew from previous weeks that  germany passed a vote  on sept. 29th, to increase their contribution in loan guarantees to $287B.  This already covers a huge chunk of the  340B  that greece owes to the world.   And there are other contributors  like ECB,  IMF  and france etc.  would  easily  surpass that  340B  number.   So,  in these  hard facts, one can clearly  see that  greece is not the issue, because there is enough money to fund greece into  2013. 
•  On sept. 15th, The European Central Bank said it will co-ordinate with the U.S. Federal Reserve ,
   the Bank of England, the Bank of Japan and the Swiss National Bank to offer
   three-month dollar loans to banks through the end of this year.  In october, ECB extended
   these loans upto 1 year term for european banks.  So,  we can conclude that banks  have been  well funded for the short term, with  essentially  unlimited  liquiditiy.
• So,  when  france and germany  agreed last sunday  to come up with a plan to help greece buy some more time, that is a temporary  bandage  applied to  the bigger  wound  of  European  crisis. As long as the greece does not default,  european banks  dont have to write it off  as  losses  and  face  liquidity  crisis.  As you have read in headlines last week,  the troika inspectors passed greece, and  the next installment of  funding has been scheduled to  be released soon  to greece.   So,  all  is well for now,  because  the  band-aid   buys  the market some more time to deal with the core issues.
• The core issue, which  was underlying the  market  sentiment for past 2 months  is  a lack of  confidence  in the  liquidity  of  European  banks.  This will continue to be an  issue  into 2012,  because  a contagion of sovereign debt  crisis  into  portugal, ireland and other EU countries seems inevitable, once  greece defaults (2012?).
• IMF estimates that broader  problems (like contagion/CDS etc.), have increased european bank exposure by about 300B euros. That is 300*1.35 = about 575B usd.   This is just  the conservative  estimate  from  IMF, i think,  because  private  estimates  have  put a price tag between  1-2 Trillion  usd,  if  the debt crisis  spills over into  other EU countries. There are  estimates  that Global banks have raised  about 100B usd in private funding in 2011, but this is peanuts compared to what they might hold in the debt of  AAA rated countries like  France.  Imagine what would to these bank  debt holdings,  if  france  lost its   AAA rating.  They have to write down lot more than the 100B they have raised :-)
• European officials were discussing ways to strengthen the 440 billion euro   that is  available  to  the  main  bailout  mechanism  being put in place -   European Financial Stability Fund (EFSF)- possibly leveraging it to the tune of 1-2  trillion euros. But germany is opposed to this, given the public sentiment towards further bailouts. I expect this  discussion  to go past  G20 summit in  november, because i can already  see  complacency  again  in the  G20  finance ministers  meeting that  was held  this past weekend.   Nothing  came out as  action item,  but only  a news release that  G20 agrees that  europe must solve its  problems;   duh, we already knew that, and we dont need G20 finance ministers to tell us that:-)  Reading between lines of the initial text released, i  suspect  the  currency war is  taking  center stage again, given the tension mounting between  US and china (but that's a seperate topic).
• So, bottom line is that the band-aid will work until  2012, when we will face european bank crisis again, in my opinion; after all, WSJ published on oct. 7th,  that U.S. Bank Exposure to Europe Could Be $640 Billion,
  as Per Congressional Paper. (roughly 5% of bank assets).  Thats  relatively  minor risk at 5% of assets, and you can imagine the number for  european banks, which hold  much bigger  exposure to  their  sovereign  bonds. If you want to read more about  the long term problems,  EFSF, and defense against contagion,  then i will point you to a  well written article here at http://www.alterforex.com/4-ways-to-leverage-up-the-efsf.