Monday, June 06, 2011

Betting On the PIGs

The BIS today released some very interesting new data (pdf) on the exposure of various parties to debt issued by the PIGs (Portugal, Ireland, and Greece). There is a lot of good stuff in this data -- particularly what it tells us about who is betting which way on a default by one of the PIGs. Let me first make three observations.

Observation #1. Default Insurance Matters.
First, the BIS data very helpfully breaks exposures into two pieces: direct exposures, which basically means creditors who own bonds issued by one of the PIGs; and indirect exposures, which for the most part means agents who sold default insurance to creditors, primarily through credit default swaps. As summarized in the following table, it seems that approximately 30% of total potential exposures to debt from the PIGs are covered by default insurance (see the figures in red). Put another way, if one of the PIGs defaults, creditors who actually hold bonds from that country will absorb about 70% of the losses, while agents (primarily banks and insurance companies) that sold insurance against the possibility of default will have to cover the remaining 30%. That's not a trivial amount. (All figures below are in billions of USD, as of the end of 2010.)

Observation #2. Direct Exposure in Europe, Indirect in the US.
The table above also hints at striking differences between how European and US creditors would be hit in the case of default by one of the PIGs. If Greece were to default, for example, approximately 94% of the direct losses would fall on European creditors, and only 5% would fall on US creditors. However, US banks and insurance companies would have to make about 56% of the default insurance payouts triggered by such an event, while European agents would make only 43% of those payouts.

The next table illustrates this difference even more starkly. In the case of Greece and Portugal, the vast majority of the losses that would be borne by creditors in Europe would be direct losses. In fact, French and German creditors would almost certainly be substantial net recipients of default insurance payments. (That's less clear in the case of Ireland.) Meanwhile, US financial institutions would have to make substantial net default insurance payments, which would account for between 80% and 90% of all losses borne by the US in the case of default (see the figures in red below).

Observation #3. Similar Overall Exposures in Europe and the US.
Finally, it's worth noting that once you account for the substantial payouts that US agents will have to make to European creditors in the case of a default by one of the PIGs, financial institutions in the US have roughly as much to lose from default as those in France and Germany. (See the figures in blue in the table above.) The apparent eagerness of US banks and insurance companies to sell default insurance to European creditors means that they will now have to substantially share in the pain inflicted by a PIG default.

This has some important implications. First, US and European financial institutions are likely to have very different incentives as negotiations regarding debt restructuring and reprofiling proceed. US banks and insurance companies are surely delighted with the "soft restructuring" that is currently being discussed. Such a partial default would probably not trigger default insurance payments, and so the pain would be borne almost exclusively by European institutions. On the other hand, some time soon it seems likely that European creditors will begin to prefer a "hard restructuring" that would require default insurance payouts from the US institutions that sold such insurance. Given how strikingly one-sided the net default insurance payments will be (from the US to Europe), it's easy to imagine how that could shape future negotiations over debt relief for the PIGs.

Second, there's an interesting puzzle here. Why have European and American financial institutions behaved so differently when it comes to the PIGs? Specifically, why have American firms been so willing to sell default insurance to the Europeans, though they have not bought much PIG debt? And conversely, why have the Europeans systematically been so eager to buy insurance for their PIG debt, even at the very high price such insurance now commands? In essence, European firms have been betting that a PIG default will happen sooner rather than later, while US firms have been betting that default would happen later or not at all.

There may be some subtle institutional reason for the dramatic difference in behavior between US and European financial institutions; I would welcome any insights or suggestions. An alternative explanation could be that there are informational differences, and/or that European financial institutions have a systematically different view of the PIGs than US financial institutions do. Could the Europeans know something that the Americans don't about the likelihood or timing of eventual default? I hesitate to believe that, but I don't have another good explanation for the one-sidedness of the betting on a PIG default...

UPDATE (June 13):
In response to questions from a number of readers, here are some details about BIS definitions.

First note that these exposures are net, not gross exposures. Here's the BIS definition of exposures on a consolidated basis as reported in this data: "The consolidated banking statistics report banks’ on-balance sheet financial claims (ie contractual lending) vis-à-vis the rest of the world and provide a measure of the risk exposures of lenders’ national banking systems. The data cover contractual (immediate borrower) and ultimate risk lending by the head office and all its branches and subsidiaries on a worldwide consolidated basis, net of inter-office accounts... [T]o reflect the fact that banks’ country risk exposure can differ substantially from that of contractual lending due to the use of risk mitigants such as guarantees and collateral, reporting countries provide information on claims on an ultimate risk basis (i.e. contractual claims net of guarantees and collateral) since June 1999." (BIS Quarterly Review, Statistical Annex (pdf), p. A4.)

Second, there's some confusion about whether what I've labeled "indirect exposures" are really comprised significantly of credit default swaps (CDS). The confusion arises from the fact that the BIS data contains a line entry for "credit derivatives" which is very small for US banks (a net exposure of about $1bn for US banks with respect to Greece in that category), but then also has an entry call "guarantees" that is much larger (about $33bn for US banks with respect to Greece). It turns out that most CDS contracts are actually probably included in the "guarantees" line of the BIS data, not the "credit derivatives" line.

Here's the explanation from the BIS guide to their international statistics (pdf, p.14):
[C]redit derivatives, such as credit default swaps and total return swaps, are only reported under the item 'Derivative contracts' if they are held for trading by a protection-buying reporting bank. Credit derivatives that are not held for trading are reported as 'Risk transfers' by the protection buyer and all credit derivatives should be reported as 'Guarantees' by the protection seller.

'Guarantees' are contingent liabilities arising from an irrevocable obligation to pay a third-party beneficiary when a client fails to perform some contractual obligation. They include secured, bid and performance bonds, warranties and indemnities, confirmed documentary credits, irrevocable and standby letters of credit, acceptances and endorsements. Guarantees also include the contingent liabilities of the protection seller of credit derivative contracts.
While we can't say for certain how much of US banks' indirect exposures to Greece are the result of CDS protection written on Greek bonds, we can say that any time a bank uses a CDS to take an open position rather than strictly for trading purposes (in which case we wouldn't expect the bank to have a significant open position by the end of the year anyway, which explains why the BIS entry for "credit derivatives" is so small), then that amount will show up in the BIS line called "guarantees". Given my suspicion that US banks are not writing a lot of letters of credit or otherwise directly issuing warranties and endoresements to Greek institutions, it seems likely that the bulk of the indirect exposure reported by the BIS for US banks to Greece is in fact in the form of CDS contracts.

UPDATE #2 (June 13): For more on this, see the new post Indirect US Exposure to the Euro Debt Crisis, part 2.


  1. Ken Houghton12:08 PM

    Uh, the Europeans rather have control over the timing/likelihood of default. (Well, the Greeks could accelerate the timetable, but the "holey spigot" [ref. Rowan Atkinson in FW&aF] of ECB cash has to be managed as a matter of SOP.)

    The question is more why any US firm would step into a rigged game. They're not likely to be able to reach across the backgammon table and use their opponent's loaded dice to win the game.

    Fitch apparently believes the timing is now Sooner Rather than Later.  Since they were--in ancient history--the organization you went to to get a higher rating than Moody's or S&P, the European banks are playing the endgame, while the US side appears to still be trying to reduce and consolidate.

  2. Chris6:36 PM

    You don't know to what degree US/European institutions have actually purchased default insurance - unless those numbers above have already been netted, which seems unlikely to me.  

    It would be truly shocking if US financial institutions had that much net exposure to PIGs.

  3. i do not see anything sinister here. with 90%+ of direct exposure, prudence dictates (and likely their risk managers demand) risk reduction. Who to buy from? well the americans have deep pockets, and are likely to want to gain some exposure that they cannot gain directly.

    I am a little unclear why US+Europe =100%. China and middle east soverign funds have no exposure? really - that seems unlikely to me.  I do not believe these are netted, so we are likely seeing only one side. Could it be that some of this is passed through to funds (e.g. US buys from China fund and sells to european bank) and we are picking up one side?

  4. Kash,

    I've not seen this BIS report before, and don't have any particular inside knowledge of it.  I'm not sure if this is right, but I have some questions about what this data actually says.

    1. On the netting: The words "positive market value only" in the Footnote to Table 9E says that these are the market values of only "in the money" derivatives.  This represents replacement value for outstanding positions at today's prices - that is different from the payout in case of default (which would be a notional value). 

    2. Let's take the indirect US exposure that you cite, of $34.1 billion in derivative protection sold on Greece.  Where do you find that in the report? I see that exact number in Table 9E, on page A103 of the report so will assume for a moment that it comes from there.

    That number, if that is in fact what you are citing, does not seem to be derivative protection sold.  First there is the whole point with respect to the market value.  But notice that the majority of this - $32 billion - is 'guarantees'.  Those aren't guarantees on government debt - at least nothing here says that they are, and most banks I know aren't in the business of writing guarantees on soveriegn debt.

    Given the size of the exposure, most likely, these are letters of credit or other credit guarantees facilitating 'trade finance' transactions.  

    The same sort of thing is true looking at the other PIGs and the US exposure - most of the exposures are coming through guarantees, which again represents trade financing.

    3. This doesn't seem to be distinguishing public sector vs. borrowings of businesses, etc.

    4. In short, I don't see anywhere in this report that actually says, "should Greece default on its sovereign debt,  here's the exposure of this country's banks to that default'.  For that you'd need to know the netted notional values of CDS written just on the public debt.  I don't see that anywhere in this document.

    I may be misunderstanding so please explain if that is the case, or point me to the numbers that you're citing on US derivative protection sold against sovereign defaults of these specific countries. 

  5. Anonymous3:02 AM

    I have a problem with these numbers.  For example, it lists total sovereign debt for Greece at $50 billion (see table 1), while in reality it is much larger (over $400 billion).  Why the discrepancy? Who owns the rest 90% of the debt? 

  6. Anonymous3:07 AM

    I have a question about these numbers.  It lists "sovereign debt owned by foreign creditors" for Greece at $50 billion.  This does not seem right.  Total sovereign debt for Greece is well over 100% of GDP (over $400 billion).  Some of it is owned domestically, but foreign ownership is definitly not 10% (I think over 50%).  Just ECB owns more debt than listed here.. Why the discrepancy?

  7. Anonymous3:13 AM

    ownership numbers for greek government debt:
    sovereign debt Eur 310 billion, and Europe owns 60% of it.
    Just European bank exposure is at Eur 50 billion.

  8. Ignacio6:10 AM


    It is true that the term PIGs has become popular altough, at least in my opinion, it is very unfortunate. It is increasingly clear to me that classifying Ireland, Portugal and Greece as PIGs (sometimes included Spain in PIGS and even Italy PIIGS) is folstering populism in Europe as well as creating associations that have more falsehood than truth. Blaming the immigrants (racism) has become popular. Blaming greeks, irish or German (depending on where you live in Europe) is also becoming popular: nationalism, populism.

    I dislike to see this kind of despective expressions in a blog as good as this one (and many others).

  9. Observer6:26 AM

    Given the problems with the Euro and dollar, it will be smart to shift to the yuan for your business dealings otherwise you will go bankrupt when the shit hits the fan.

  10. Thanks for beating up the data a bit -- it's a helpful and important part of the process of understanding it.  Here are a few notes about the data to address questions raised by commenters:

    - the BIS data only covers banks.  Exposures to central banks, governments, hedge funds, private wealth management funds, etc., are not counted here. In some cases the bank total is close to what we know is the overall total, but in other cases it is clear that non-bank entities must face substantial exposures as well.

    - the BIS data only covers 24 reporting countries.  Most east Asian and Middle Eastern countries are not covered. So this data is best used to understand the relative exposures of the US versus Europe.

    - Detailed definitions and explanations of the BIS data is provided in this document:

    The term "guarantees" is defined as follows: "<span><span>Guarantees are contingent liabilities arising from an irrevocable obligation to pay a third-party beneficiary when a client fails to perform some contractual obligation. They include secured, bid and performance bonds, warranties and indemnities, confirmed documentary credits, irrevocable and standby letters of credit, acceptances and endorsements. Guarantees also include the contingent liabilities of the protection seller of credit derivative contracts."</span></span>

  11. Ignacio -- you make a good point, and we should probably all be a bit more careful with the term.  I used "PIGs" as a common and humorous shorthand for the 3 relevant countries, and absolutely no disrespect was intended (in fact, as is probably clear from my writing, I tend to think that Greece, Ireland, and Portugal are being treated badly by the big Euro countries)... but I understand your point that the nickname may have the unfortunate side-effect of being misused by people hostile toward those countries. We should try to come up with another shorthand. I'm open to suggestions.

  12. Ignacio8:47 AM

    <span>Kash: I am sure that you don't use the term in a despective way. I have read many of your blog entries and I would never blame you for beign despective to Irish, Greek, Portugese or whoever.</span>

    I Suggest using GPI since GIP could be confused with GIPSY. Peripheral is also better than PIGS. At least it is geographically true. Euro-GPI sounds very precise and not despective.

  13. Andrew Hofer8:51 AM

    It stands to reason that you would want to buy protection from institutions without direct exposure and outside the Eurozone. If you were buying protection on the US, who would you buy it from?

  14. <span>Betting On the PIGs:</span>

  15. If your analysis is correct it explains why President Obama is so anxious to "shoulder our responsibility" for bailing out Greece.  It's a US taxpayer bailout for our own banks!

  16. Intrinsic value3:18 AM

    Great research!

  17. Anonymous11:02 AM

    I am not sure that the assessment that indirect exposure is purely from selling of credit protection is correct.  It doesn't tie in with the DTCC data regardinging Hellenic Republic.  It also seems to ignore things like the now legendary GS off market swaps that were really loans.  Transactions of that nature would be indirect exposures, and may have been dominated by a couple big players like GS.  It may also include interest rate swaps or fx swaps that have had large move?

  18. Anonymous11:31 PM

    eur banks are holding cash bonds probably because they could use those as collateral to get liquidity from ecb, but US banks can't do that from the Fed

  19. Anonymous2:06 AM

    nice articel

  20. M.G. in Progress4:10 AM

    Well same story with the US subprime... ;) : European were buying CDS insurance from AIG knowing that subprimes they were sitting on were junk bonds and toxic assets. Now they buy insurance for their PIG debt knowing those countries are likely to default.
    There is definetly some informational and market differences which I wrote about calling it debt market for lemons...
    Sovereign debts: markets for lemons and Ponzi schemes

  21. Anonymous9:32 AM

    Did you adjust your CDS numbers for the expected % payout, or did you report it as if a default requires 100% payment?

    Also, how have you netted CDS exposure? Given their is a long and short side? If you are only counting the amount of CDS underwritten, who is to say that US banks aren't on the hook for more simply because US hedge funds are demanding more product?

    I think you HAVE to get the indirect numbers using an assumed payout % and net!!!

  22. Anonymous9:38 AM

    Also - don't you need to time scale the CDS exposure?  I'm a newb in CDS but it SEEMS to me that  6 months ago you should have been a lot more concerned underwriting a 3 month CDS vs a 10-year.  But you got paid more for 3 year then for 10, so could have written 3 months and covered by buying 10 years.  And looking back that would have worked wouldn't it?  Maybe its an income strategy?

  23. Anonymous12:08 PM

    have you confirmed whether the U.S. bank exposure noted by the BIS is gross or net exposures? - that could make a material difference to your conclusion


  24. Anonymous12:21 PM

    you  are misinterpreting the BIS data.  Of the 60mm that is other, only 7 is derivatives contracts. most are guarantees extended to greece as reported in the document.  The 7mm is in line with what DTCC reports.

  25. Anonymous2:30 PM

    Actually, we can tell how much CDS would be triggered in a default of one of these countries, and it is a small amount.  According to DTCC (, the current total net notional outstanding (that is, the most money that could change hands in a default resulting in a credit event (and assuming a zero recovery, which is unlikely), for each of those countries is:

    Portugal - $7 billion
    Greece - $5 billion
    Ireland - $4 billion

    Conclusion: The "Other exposures" category contains little CDS unless they are ignoring bilateral netting and reporting meaningless gross numbers. For instance, if Bank A has written $100mm of protection to Bank B on an issuer and Bank B has written $90mm to Bank A on that same issuer, the gross exposure would be $190mm, but the net (i.e., real) exposure between those two counterparties would only be $10mm.  Also, the sub-category "Guarantees extended" includes a lot of other things besides CDS, like letters of credit, guarantees of certain subsidiaries' indebtedness, BAs, etc.  Those "Guarantees extended" appear to be large, and could be concerning unless there is a "grossing up" issue as noted above. But it doesn't look like the blame can be laid at CDS's feet, as it is actually diminimus compared to the liabilities involved.

  26. BIS data complex for a non-economist. Can you please explain how you calculate total debt held by foreign creditors for Ireland.  Rob

  27. Anonymous5:39 PM

    Hi Rob,
    I sympathize -- it's not easy figuring out how to interpret the data.
    Unfortunately, I don't think you can use the BIS data to calculate the
    figure you're looking for, because the BIS data is only for banks, and
    specifically only for banks in 24 countries (mainly the US, Canada, and
    Europe). In other words, it will tell you how many Irish bonds are owned by
    US and European banks, but it won't tell you how many Irish bonds are held
    by investment funds, private investors, banks in Japan or China, etc.
    But to see how much Irish debt is owned by banks in Europe and the US, look
    at table 9E of the BIS report that I reference in the post. Then on page
    A104 you see that total direct net exposure (i.e. after default insurance
    kicks in) to Irish debt to banks in Europe and the US is about $462
    billion. Most of that is debt issued by Irish corporations other than
    banks. $19bn of it is debt issued by the Irish government. And about $85bn
    is net exposure to debt issued by Irish banks.
    Hope that helps,
    On Mon, Jun 13, 2011 at 3:37 PM, Echo <

  28. Note that the DTCC data you cite is only for sovereign debt.  The bulk of the exposure is likely to be to debt issued by banks and other corporations in Greece, Ireland, and Portugal.

  29. <span></span>
    Why EU banks hold PIG debt (capital adequacy standards required it)

    They knew that the bonds weren't risk free (as regulations assumed) so they bought insurance.

    German news reported German banks have sold 1/3 of their holdings. (Not sure when/who)

  30. Chris Miller10:02 AM

    Guess there is more to money and banking than we are aware of. The gist of this is: if Greece defaults, our banks have insured them (it's called derivatives) against default & guess who will have to pay? American taxpayers. Somewhere around $41.4 billion for Greece, $46.5 for Portugal, and $105 billion for Ireland...payable to the lenders Germany, France & other lenders.

  31. Justin Reckers, CFP®11:13 AM

    Great piece. Most people seem to not understand the potential magnitude of the European debt crisis for the rest of the world through it's counter-parties. Thanks to John Mauldin for pointing me your direction. It is time for the banks to take a hair-cut on debt holdings not just Amercian stock-holders. 
    Justin Reckers, CFP - 

  32. Anonymous3:30 PM

    can you please explain what tables you used to calculate indirect exposure, and how those tables and footnotes lead you to the conclusion that the large indirect exposure number is equivalent of naked selling of CDS? 

  33. Anonymous3:33 PM

    the notes for table 9 say that these are exposures without taking into account collateral or margin against? 

    i believe the bulk of 'indirect exposure' is custodial/repo business where the banks hold these bonds for hedge funds etc, and are fully collateralized against them.

    That would actually make sense and tie in with DTCC numbers and the footnote.

  34. Anonymous3:38 PM

    there is now way that much protection was written on all entities combined other than the sovereign.  there is barely a single name CDS market for Greece, it is extremely unlikely u.s. banks had that exposure on names smaller than the sovereign

  35. Homer8:10 AM

    Lovely how our banks are far from eager to make loans to Main Street Americans, but chomping at the bit to underwrite CDS on Greek debt.   Looks like we need more regulation for our banks.   I have no problem with our banks being stripped of almost every service other than taking in deposits and making term loans to individuals and corporations.  All this other exotic garbage is completely in-appropriate for institutions funded with FDIC deposits.  15% SIFY capital buffers too!

  36. thanos6:16 AM

    the first example is wrong. the greek sovereign debt that is held by foreign banks is only 54 billion!the 145 billion figure is the total greek debt (public and private). so the 60 billion indirect exposure concerns greek banks, corporations etc.

  37. Anonymous8:12 AM

    this data has been shown to be incorrect...he is just plain wrong...a couple articles after this one,he backtracks a bit, but even that is not enough...he is wrong.  bernanke addressed the BIS in his press conference and confirmed this data is not what Kash says it is. 

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  39. Janie Graham3:41 PM

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