What do Greece, AIG, and Spanish Banks have in Common? US Taxpayers!

By
Industry Observer with NMLS ID: 40831

I ran across two articles today that are each individually quite concerning to those who understand the precarious nature of the global economic recovery. However, in putting the facts of these two article together, the big picture just got a lot scarier.

An article entitled "'Bastante mal' for Spain's banking shares"in MarketWatch today exposes the deteriorating situation of the major Spanish Banks. These banks have seen a steady, and significant decline in 2010 due to doubts over the country's ability to reign in government spending (sound familiar?), coupled with a nearly 20% unemployment rate (again, sound familiar?). Most people have not noticed the problem in Spain because Greece is getting the headlines, but Spain is not far behind, and their economy is substantially larger than Greece. Both Barclay's, and Moody's issued downgrades to the major Spanish banks, and their associated securities (approximately $32 Billion) stating that in comparison to other major European banks they "are likely to be eroded "significantly" owing to increasing signs of stress in Spain's domestic property exposures and fears over the fiscal situation there."

The article goes on to tell how Markets & Investors are "fretting" over reports that the Bank of Spain is going to raise Minimum assets held as provision against repossessed real estate (Familiar?) to 30% from 20% which was only 10% as recently as November. This was confirmed by Spain's Central Bank Governor.

While this is not good news, it is not Earth shattering, or Global Economy rattling. That is until you see what Karl Denningerposted today concerning the latest fallout from AIG, and I'm not talking about today's reported 4th qtr. loss of another $8.9 Billion. Denninger found a bombshell in the company's 10Q reports (In the 10-Q, firms are required to disclose relevant information regarding their financial position quarterly) that they have an exposure of an additional $150 Billion in Credit Default Swaps (CDS) which are mainly derivatives for European Financial Institutions like the Spanish Banks.

I know CDS are complex, and most people just understand them as an insurance against bad bets, but bear with me. Here's the devil in the details of the report concerning the nature of these CDS "AIG understands to have been originally written primarily for the purpose of providing regulatory capital relief rather than for arbitrage purposes." So what exactly does that mean? Denninger explains it best "So AIG "understands" that $150 billion of credit-default swaps were written by AIGFP to European Institutions (no note by the way as to exactly what's in there - or who owns them) for the explicit purpose of getting around capital requirements - either by banking regulators or (possibly worse) EU sovereign regulations.

What this means is there is a distinct possibility that AIG knew these were being written as a "magic" way to create Capital where it specifically did not exist. The 10Q shows that the net fair value for these CDS is only $116 Million, meaning they are pennies on the dollar compared to liability. Now put that information together with what is the verge of a default by the country of Greece, and then extrapolate it to the much larger country of Spain. Since Spain is possibly going to require further capitalization on the part of their banks, and this could be the smoking gun that the last increase was nothing more than a Bernie Madoff illusion, where does that leave us?

Remember those bonds I mentioned being downgraded by Moody's and Barclay's? Well, expect foreign investors to want to sell them before they take too big a loss, which in turn will put more pressure on interest rates. This typically leads to a spiral effect of deteriorating currency that can make it impossible for the country to repay its debt when those bonds are denominated in a foreign currency (US Dollars?). With Greece this does not apply as most of their bond problems are denominated in Euros. However, Greece then has the problem of not being able to hyper-inflate/print their way out of the problem.

So what happens when Spanish banks are unable to raise the necessary capital to meet the new requirements? They will cash in those CDS that AIG never thought they would have to pay out is the best bet. However, no one knows for sure because AIG has confidentiality clauses pertaining to these CDS, but I'm betting the American taxpayer will then be on the hook for bailing out Spain.

How does it feel to be in a position to have bailed out the US banks on the order of Trillion$ over the last year, and now we're looking at the same for Spain?

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Rainer
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Dan Sanley
La Mesa, CA

Ron forgive me if I say "This is complicated!" 

The non surprise here is that U.S. taxpayers are helping to bail out banks in Europe.  And to a greater extent than just what you mention here. Back in March of 2009, after we taxpayers gave bailout money of at least $170 billion plus an $85 billion (loan), some of that money began immediately going to European banks.  At that time I know Societe Generale got $13 Billion and Deutsche Bank $13 Billion.  Other Europe banks combined got Billions as well.  Fox News reported that AIG had exposure of $300 Billion to Europe banks at that time, with 30% of that coming due in 2009.  I can't find if in fact more money was given to European banks or what happened to this 30%.  The key to knowing that may well paint the potential exposure for the remainder, which looks like $150 Billion.

AIG reports that at the end of 2009 there was $150 Billion of CDS extended to mostly European Banks, and currently most of that is considered risk.  It certainly does look like we, the U.S. taxpayer will end up helping European banks, and for a very large amount we will never recover.

What is new is the express reason for the creation of the CDS instruments, to "Provide regulatory capital relief".  Sounds like some funny business going on here as well, which could result in penalties and further cost to tax payers.

Yes, some of the Spanish banks were in on this deal, and Spain's economic situation is a mess.  Expect their banks to be collecting what is due them, soon.

Feb 27, 2010 06:13 AM #1
Rainer
69,682
Dan Sanley
La Mesa, CA

Another angle on this whole thing is the the CDS instruments are not real if they were issued with "side letters" where both parties agreed that the reinsurance contract was created as window dressing to make the bank look better on paper, but where the seller had no intention of ever paying out on the contract.  I would think this should be illegal, but it has gone on in the past.  If this is the case then the exposure may not be as great as it appears, but there is still an exposure, and maybe some jail time for someone.

 

Feb 27, 2010 09:53 AM #2
Rainer
129,004
Ron Brown NMLS #270845
NMLS ID: 40831 - Federal Way, WA

Dan - You are right on in the idea that this was likely just window dressing in order to satisfy the Spanish Central bank reserve requirement.  It is deals like these that could potentially trigger another global financial crisis, and why there is so much concern over the size & scope of the CDS market exposure.  We are dealing with anywhere from as "little" as $65 Trillion to as much as $600 Trillion in risk exposure depending on who you chose to listen to. 

This is just on more reason that the Federal Reserve needs to open their books.  We don't know, and many like myself do not trust, that they have not monetized not only their own debts, but the debts of all the developed nation's central banks in concert.

Feb 28, 2010 03:07 PM #3
Rainer
69,682
Dan Sanley
La Mesa, CA

Ron, see my post which a continuation of this discussion.  I began it as a comment here and it got too big.

http://activerain.com/blogsview/1527329/the-european-pigs

Mar 04, 2010 05:00 AM #4
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Rainer
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Ron Brown NMLS #270845

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