Thursday, July 08, 2010

EU Banks - stress test farce

Good article from Forbes just released on the web. Read here. A short quote:

After so many months of angst as to the fate of Greece and then Spain, when special funds and loans have been arranged to keep such nations afloat, the idea that a reduction in asset value or “haircut” of just 17% on Greek debt and 3% on Spanish is more like Alice in Wonderland than Banking in Euroland! Given that the European Central Bank has been mopping up Greek bonds it perhaps no wonder that the haircuts are not stringent enough!

The haircuts are of no value at all especially since the market is pricing Greek credit default swaps to imply a 40% chance of a default and Spain CDS's to suggest a 25% possibility of default. This is more like a white wash as derivatives called “recovery swaps” currently trade at a rate that says in the event of a default investors holding Greek paper would lose 60% of face value, meaning they would get back just 40%. For Spain the loss is 25%.



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