PIIGS is not the most flattering acronym to describe a group of countries, but Portugal, Ireland, Italy, Greece and Spain may have to make due for the time being. The name is thrown around to describe a set of eurozone countries considered to be the most at risk when it comes to sovereign debt and has grown more popular by the frequency at which stories relating to their economic woes appear in the news. Images of rioters in Greece and protesters in the streets of Spain have come to symbolize both the follies of governments and the fear of future austerity.

TUTORIAL: Credit Crisis


Three "Little" PIIGS Crises
Portugal, Ireland, Italy, Greece and Spain are in trouble – this is a given – but looking at individual statistics doesn't show how complex the current situation is. There are really several crises occurring in rapid succession: a crisis related to PIIGS banks' exposure to debt, a crisis related to PIIGS government debt and a crisis related to non-PIIGS banks' exposure to PIIGS debt.

The first crisis is related to government debt. Take general government gross debt as a percentage of GDP. We've got some pretty high numbers: 83.9%, 82.3%, 75.5% and 94.3%. Those aren't for the European countries on the brink of collapse; they are for Germany, France, the United Kingdom and the United States, respectively. The figures for Ireland, Italy and Greece are 94.9%, 118.9% and 142.7%, respectively. They are much higher. Government debt levels are expected to increase in the coming years due to deficits, pensions and rising healthcare costs.

PIIGS banks' exposure to their own sovereign debt is troubling. Of the $763 billion in sovereign debt held by 90 European banks, 59% of it was held by banks in the country that issued it in the first place. Spanish banks hold 78% of their country's sovereign debt. As the risk of holding that debt increases, these domestic banks will find it increasingly difficult to get funding from other financial institutions. This is especially concerning because these banks rely heavily on wholesale sources of funding, and these sources will become more expensive as countries lose their creditworthiness. Suddenly you have sovereign risk becoming general bank risk.

The third crisis relates to non-PIIGS financial institutions exposure to PIIGS sovereign debt. Spreads on sovereign debt bonds over German bunds grew wider as investors' faith in PIIGS government wavered, and were hit especially hard by a Greek debt downgrade in April 2010. Yields on two-year Greek debt jumped from below 10% in October 2010 to above 76% in October 2011 and 10-year debt rose from 5% to 24%. European governments have certainly taken note of this, since they know that in order to preserve the euro they will have to prop up PIIGS governments or allow them to go through default in a semi-orderly manner. (For more insight to the correlation of risk and governments, read The Government And Risk: A Love-Hate Relationship.)

PIIGS and The Banks
Then there are European banks. The European Banking Authority (EBA) conducted a stress test on 90 different European banks, including an examination of their exposure to government debt. When banks were not "allowed" to raise capital, their average Capital Tier 1 (CT1) ratio fell from 8.9% to 7.7%. If banks were required to raise capital, eight would have CT1 rates below the 5% threshold set forth in test, and a further 16 would be perilously close to falling behind. Without capital raising, 20 banks would fall below 5%, which is a frightening statistic because banks may very well lose access to capital if governments start to default. The EBA found that 42% of bank funding came from wholesale and interbank sources, rather than less risky consumer deposits. If markets freeze up, banks won't have access to capital. (To learn more about how the Tier 1 Capital Ratio measure a bank's health, check out Is Your Bank On Its Way Down?)

Sovereign Debt

This brings us to bank exposure to sovereign debt. The 90 banks reviewed by the EBA had gross exposure to PIIGS debt of $763 billion, with 80% coming from Italy and Spain. Fourteen of the 90 banks had more than $30 billion in individual exposure, including BNP Paribas (France), Intesa (Italy), Unicredit (Italy) and Banco Santander (Spain). If the EBA requires banks to shore up their Tier 1 capital, these banks could find themselves well short of the requirements. As the value of sovereign debt bonds declines, the balance sheets of these banks look worse and worse.

The more out of control this amalgamation of financial terror becomes, the worse off European businesses will be. This is especially true considering how some of the more healthy European economies wind up sending a lot of exports to PIIGS countries. In 2010, Germany exported $1,300 billion worth of goods, with Italy ($75.6 billion), Spain ($36.9 billion), Portugal ($10.10 billion), Greece ($6.1 billion) and Ireland ($4.65 billion) representing roughly 10% of all exports. Because this is a cascading problem, once exports start to fall so too will unemployment rise, tax receipts dwindle, unrest build and bank runs pop up. In short, it's a mess.

The Bottom Line
There is no easy solution to this crisis, but one thing that everyone can agree on is that no one wants disorderly government defaults. Banks will have to be recapitalized, just as they were in the United States in 2008. The composition of debt held by banks will need to become more diversified, since it was the reliance on "safe" sovereign debt that put them in the precarious position that they are in today. Banks will have to show their hand in terms of their debt composition, which will make investors more confident in the health of each bank. Government regulations will have to ensure that sovereign risk is kept separate from bank risk, which will require an end to implicit government guarantees of support for banks in times of trouble.

Related Articles
  1. Fundamental Analysis

    3 Times the FOMC Got It Right This Century

    Learn about three times that the Federal Open Market Committee (FOMC) and the Federal Reserve took positive steps to help the economy in the 21st century.
  2. Fundamental Analysis

    Quantitative Easing Report Card in 2016

    Find out why quantitative easing has not worked, despite the best efforts of the Federal Reserve, and how it has fueled the national debt problem.
  3. Investing News

    How Interest Rates Can Go Negative

    Central banks from Europe to Japan have implemented a negative interest rate policy (NIRP) in order to stimulate economic growth.
  4. Budgeting

    Is Living in Europe Cheaper than in America?

    Learn how living in Europe has financial advantages over living in the United States. Discover the benefits to take advantage of when it makes financial sense.
  5. Economics

    The Delicate Dance of Inflation and GDP

    Investors must understand inflation and gross domestic product, or GDP, well enough to make decisions without becoming buried in data.
  6. Economics

    The 2007-08 Financial Crisis In Review

    Subprime lenders began filing for bankruptcy in 2007 -- more than 25 during February and March, alone.
  7. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  8. Investing News

    Brazil's Latest Export To China: Soccer Players

    Why are Brazilian soccer players moving to China?
  9. Personal Finance

    5 Places Where Your Travel Dollar Goes Furthest

    The dollar is pretty strong right now, but where is it strongest? Canada? South Africa? Europe? Here are five places to travel to right now on a budget.
  10. Stock Analysis

    6 Risks International Stocks Face in 2016

    Learn about risk factors that can influence your investment in foreign stocks and funds, and what regions are more at-risk than others.
RELATED FAQS
  1. What is comparative advantage?

    Comparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it ... Read Full Answer >>
  2. How does the Wall Street Journal prime rate forecast work?

    The prime rate forecast is also known as the consensus prime rate, or the average prime rate defined by the Wall Street Journal ... Read Full Answer >>
  3. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
  4. How do you make working capital adjustments in transfer pricing?

    Transfer pricing refers to prices that a multinational company or group charges a second party operating in a different tax ... Read Full Answer >>
  5. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  6. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
Hot Definitions
  1. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  4. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  5. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
Trading Center