Even Moody's downgrade of Irish government bonds on 22 July, which came hot on the heels of a 14-July downgrade of Portuguese debt, has failed to reignite the flames.

On Monday, the New York Times published a long article, which documents "how quickly investor psychology has changed." Not only are investors not withdrawing from the eurozone, it appears they are returning - a fact reflected by Greece's successful re-emergence on the debt markets with a 1.65 billion auction of six-month bonds on 13 July. The 4.65% rate of interest the Greek government will have to pay remains high, but it is barely more than the rate it had to offer two months ago, before the announcement of the country's austerity package.

Spain, which had been threatened by contagion, also staged three well-subscribed bond sales in July. Bond auctions in Portugal and Italy were equally successful. As a consequence, the European Central Bank (ECB) has been able to cut back on its government bond purchases, after having mopped up 60 billion euros of sovereign debt: a sign that the situation is returning to normal.

July 23 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said extending at least some of the tax cuts set to expire this year would help strengthen a U.S. economy still in need of stimulus and urged offsetting the move with increased revenue or lower spending.

"In the short term I would believe that we ought to maintain a reasonable degree of fiscal support, stimulus for the economy," Bernanke said yesterday under questioning from the House Financial Services Committee's senior Republican. "There are many ways to do that. This is one way."

(Reuters) - Investors are finding themselves with a new kind of balancing act -- one in which they have to juggle with three major regions posing three significantly different circumstances.

Europe's bank stress testing, the focus of much of the past week's market debate, may have some impact on Monday but may well pale into insignificance given the most recent numbers on the broader economy.

First there is the United States, which is believed to be facing another slowdown, if not a double-dip recession.

Then there is Europe, suffering a debt crisis and austerity-bound, yet suddenly surprising everyone with an unexpected burst of economic vigor.

Thirdly, comes Asia, growing away so merrily that investors are beginning to be concerned that too much zeal will be exercised in trying to slow things down.

So where are the trillions of dollars of bad loans that the banks had on their books? They are still there. The Federal Reserve took possession temporarily of some of them as collateral for lending to the banks in an attempt to clean up the banks for their supposed" stress tests". But as of now, the trillions of dollars of underwater mortgages, CDO's and worthless credit default swaps are still on the banks books. Geithner is going to the familiar "bank in crisis" playbook and hoping that the banks can earn their way out of their solvency problems over time so the banks are continuing to slowly write off their problem loans but at a rate that will take years, if not decades, to clean up the problem.

And this is where defeat of the nomination of Elizabeth Warren becomes critical for Geithner. For Geithner's strategy to work, the banks have to find increasing sources of profitability in their business segments to balance out their annual loan loss recognition from their existing bad loans in an environment in which they continue to recognize new losses in prime residential mortgages, commercial real estate lending, sovereign debt investments, bridge loans to private equity groups, leverage buyout lending and credit card defaults.

The banks have made no secret as to where they will find this increase in cash flow. They intend to soak their small retail customers, their consumer and small business borrowers, their credit card holders and their small depositors with increased costs and fees and are continuing many of the bad mortgage practices that led to the crisis (ARM's, option pay deals, zero down payments, second mortgages, teaser rates, etc). American and Banking Market News reports this week that the rule changes in the financial reform bill may lead banks to start implementing fees that had essentially disappeared from the industry early in the new millennium, such as fees for not meeting minimum balance requirements on a checking account, or reinstituting fees for certain online banking transactions that are currently free or charging to receive a paper statement or to talk to a live teller as Bank of America's CEO has recently proposed.

Citigroup, Bank of America and 15 other bailed-out financial services companies overpaid their top executives by $1.6bn during the height of the financial ­crisis, according to a review by the White House's ­special master on Wall Street compensation.

Kenneth Feinberg, who was appointed last year by Barack Obama, president, to oversee the pay policies at the companies that received the greatest government support, began in March his latest inquiry into top executives' compensation from late 2008 to early 2009.

While the payments were legal at the time, Mr Feinberg said on Friday, they would have fallen foul of restrictions the government set for participants in its troubled asset relief programme (Tarp).

In the figure below, I show an index of eurozone real GDP, from Eurostat, with 2007 fourth quarter -- a quarter in which Europe was doing OK, but certainly not experiencing inflationary overheating -- set at 100. And I compared it with a trend assuming 2 percent annual growth in potential output, a fairly conservative assumption even for Europe. Here's what it looks like:

Eurostat, author's estimate

So a huge gap has opened up between a reasonable estimate of potential output and actual output. Even if you believe that growth in Europe has picked up since the first quarter -- and that the pickup will continue -- it will take years to close that gap.

CR Note: This series is from reader "some investor guy".

Part 1: How Large is the Outstanding Value of Sovereign Bonds?

Part 2. How Often Have Sovereign Countries Defaulted in the Past?

Part 2B: More on Historic Sovereign Default Research

Part 3. What are the Market Estimates of the Probabilities of Default?

Part 4. What are Total Estimated Losses on Sovereign Bonds Due to Default?

Part 5A. What Happens If Things Go Really Badly? $15 Trillion of Sovereign Debt in Default

In Part 5A, I showed a Really Bad scenario consistent with some very bad historic default rates for sovereign debt. That produced an estimate of $15.3 trillion of defaulted sovereign debt, with $7.5 to $10.5 trillion of losses.

In today's post, we look at the effects of sovereign default on credit default swaps, interest rate swaps and options, and currency exchange contracts.