European Bank’s PIGS Exposure

There is quite a lot of back and forth on just how important Greece is to the global financial situation. You have some commenting that if we are so concerned about Greece, why aren’t we freaking out about California, an economy with a larger deficit and a larger GDP (California’s economy is about the size of France). I can’t argue that California is definitely an issue, but at this moment, it certainly is not the focal point we should be looking at. While Greece by itself might very well be a containable problem, it represents a much larger problem. This chart might just help clear this up.

Source: Bloomberg

I did a back of the envelope calculation using the numbers from this graph, but I see about $1.3 trillion of PIGS sovereign debt in German, French, Swiss and British banks.  That is certainly a large exposure.  The issue is not just a Greek default, but if you’ve seen CDS spreads over the last 2 months, they have blown out considerably.  Remember all of those crappy fixed income assets that the World’s largest financial institutions were holding in late ’08 which almost crashed the system?  Well many of these governments implicitly or explicitly took over those assets.  And guess what all of those banks have been buying recently to juice up profits from a steep yield curve?  You got it, sovereign debt.  Its created sort of a perverse circular logic.  The Eurozone is worried about funding costs increases for many of its countries and is also concerned that its major banks will have to mark-to-market that $1.3 trillion worth of Sovereign debt.  While certainly any help to Greece may put a floor on “panic” in the short term, as you can see Spain and Ireland are much greater concerns for Europe’s big banks. 

It almost seems like 2008 replaying all over again, with a short term fix placating the market temporarily, but not fixing the larger issue still looming.  We all know how that ended…

It may seem wise in this context to use any relief rally in European banks to take exposure off the table or to build short positions.

Selling any exposure to IXG on strength might be a good call.   If you are interesting in building short positions the better play may be to just short individual names.

An interesting play might be pairing off shorts of European banks with an index like XLF or IYF which have exposure mostly to American domiciled banks.

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