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Reggie Middelton made a presentation to ING in Amsterdam where he noted that the stress tests only tested the trading book of the banks, which is usually no more than about 10% of the total book. He also noted that almost all banks, when they bough sovereign debt, did so with about 10:1 leverage. This led him to conclude that the total exposure of European banks to sovereign default was grossly underestimated. In a default it does not matter where the bank carries the debt as their whole book is at risk and 10:1 leverage would produce a 100% loss on a 10% haircut. The leverage means that a small default can have big consequences.

Text and links are at his BoomBustBlog. Double click on the video so as to watch it on YouTube where graphs will be readable.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere." (But it helps!)

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 14th, 2011 at 11:28:05 PM EST

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