THE BLOG
06/19/2011 08:11 pm ET | Updated Aug 19, 2011

The Contagion of Write-Offs in Europe

There must be a contagion of write-offs, sooner or later. Take Greece for example; its 2 year notes are yielding over 29%, but the institutions holding that debt are still valuing the paper at 100 cents on the dollar. And that's just Greece, a small nation on the eastern border of Europe.

What about the debt of Ireland, Portugal and Spain, not to mention Italy, whose impeccable AA credit rating was just lowered a notch? We are talking about a contagion that Tyler Durden of Zero Hedge suggests is part of narrative in the new financial crisis drama entitled "The Countdown to Sovereign Debt Write-offs Has Started."

Who, pray tell, has the exposure to the debt issued by the most troubled European nations?

On December 14, 2010, Streettalk (that's me), using a Bank of International Settlements report, discovered the humungous $1.5 trillion Greece, Ireland, Portugal and Spain owed to all European banks. Those 4 nations also owed $353 billion to US banks. Total owed: $1.853 trillion. Of this $1.853 trillion, some $668 billion was somehow related to derivative exposures (exactly how was not made clear enough for me in the BIS report.)

Luckily for me, a Columbia University economist, Charles Calomiris, got in touch with some incredibly worrisome breakdown of the relationship of these loans to the GDPs of the nations extending the credit.

French banks had lent 9% of France's GDP to Spain; Dutch banks fully 16.4% of Holland's GDP to Spain; and Portugal's banks: 13% of Portugal's GDP to Spain.

German banks had lent 12% of the German GDP to Ireland and Spain British banking giants Barclays and HSBC had lent 9.4% of the UK GDP to Ireland and another 5.7% to Spain.

The Greek contagion has already made insolvent the Greek banks, while 3 French banks may have their credit ratings reduced. As the securities of Portugal and Ireland decline in price and rise in apparent yield, it raises significantly the issue of marking to market the holders of Portuguese and Irish loans, which are also being carried at par.

Contage another step to the sovereign debt of Spain and Italy, where yields are rising, and the premium cost for insuring against default gets higher every day. What happens if there is further weakness in Spanish real estate or trouble at the Italian banks, suggests Edward Harrison of the Credit Writedowns blog.

You can see how the chain could continue from nation to nation, from bank system to bank system, from central bank to central bank. It makes me think of the rolling financial crisis that began with the meltdown of subprime mortgage backed bonds, moved to Alternative A mortgages, then to prime, and onto LBO loans, and money market funds -- culminating in the end of Bear Stearns, Lehman Brothers and causing shotgun marriages of Wachovia, Merrill Lynch and the massive bailout of AIG.

What then happens to the fragile US banks that either own $350 billion European sovereign debt, or purchased credit default swaps to protect themselves. How will all this transatlantic web of relationships be resolved, unwound, stabilized? I'm exhausted just writing