So the worst kept and most predictable secret happened over the weekend with the Spanish bank bailout. I don’t think I need to go through the details. I am sure anyone who cares about it has already read at least 10 articles on the fact that Spain has secured up to a €100bn loan from Europe in order to recapitalise its ailing banking system.
Initially the deal appeared positive for Spain, but as usual the devil is in the detail. It must be noted that I don’t consider this something that, by itself, changes the medium to long term outcome of the country. This is simply a new loan that will be required to be paid back and doesn’t change the fact that the Spanish government is still attempting to deleverage while the private sector does the same in the absence of a true floating currency or an offsetting current account surplus.
Supposedly these loans will give the Spanish banks the ability to re-capitalise and begin lending again, but this seems fanciful. This is the same story we heard the ECB when the 3 year LTRO was announced and it completely ignores the fact that even if the banks were capable of lending no one wants the debt. The Spanish unemployment rate is nearly 25% and by the government’s own admission the economy is going to get worse over the next year. It defies all logic that anyone expects the private sector to have renewed vigour for credit under these circumstances even if the banks were in a state to grant it.
There are a number of outstanding questions for the bailout, the most notable being exactly where and under what terms the money will come. According to the Spanish government, this package requires no further fiscal measure to be implemented by the Spanish but this appears contrary to the framework of both the EFSF and the ESM ( please see more here ).
Although it is yet to be ratified by the German parliament, the ESM is supposedly the target for the bailout. However, given the mechanism isn’t in place it is possible that the funds will firstly have to come from the EFSF. If that is the case then, as with Greece, the Finnish government will demand collateral.
The Rajoy government has attempted to frame this as a non-sovereign loan to the banking system, but that doesn’t appear to be a valid description of what this actually is. The money will be paid in through the Spanish fund for orderly bank restructure, the FROB, which by its own documentation states that its issuances have:
explicit, unconditional and irrevocable guarantee of the Kingdom of Spain.
So, as far as I can tell, no matter where the money actually comes from, and whatever the terms, the sovereign, not the banks, will be ultimately responsible for the new loan. In an environment where the economy continues to contract, unemployment remains staggeringly high and industrial production continues to sink, this is not at all positive for sovereign risk or the people of Spain.
As I said above, what the Spanish government has been saying appears to be contrary to the ESM and EFSF treaty documentation. If we look at the ESM documentation it very clearly states, just like the EFSF before it, that there is a memorandum of understanding that needs to be created which defines the parameters of the loan:
If a decision pursuant to paragraph 2 is adopted, the Board of Governors shall entrust the European Commission – in liaison with the ECB and, wherever possible, together with the IMF – with the task of negotiating, with the ESM Member concerned, a memorandum of understanding (an “MoU”) detailing the conditionality attached to the financial assistance facility. The content of the MoU shall reflect the severity of the weaknesses to be addressed and the financial assistance instrument chosen. In parallel, the Managing Director of the ESM shall prepare a proposal for a financial assistance facility agreement, including the financial terms and conditions and the choice of instruments, to be adopted by the Board of Governors.
We are obviously yet to see such a document, so until we do it is very difficult to analyse exactly what Spain has actually signed up for, but others appear to have a very different versionto the funding utopia Mariano Rajoy has been telling his country about.
Spain faces supervision by international lenders after a bailout for its banks agreed at the weekend, EU and German officials said on Monday, contradicting Prime Minister Mariano Rajoy who had insisted the cash came without such strings.
EU Competition Commissioner Joaquin Almunia and German Finance Minister Wolfgang Schaeuble said that as in those other bailouts, a “troika” of the International Monetary Fund, the European Commission and the European Central Bank would oversee the financial assistance.
“Of course there will be conditions,” Almunia told Spain’s Cadena Ser radio. “Whoever gives money never gives it away for free.
The IMF would be fully involved in monitoring Spain’s program even though it was not contributing funds, and banks that received aid must present a restructuring plan, he said.
Schaeuble told Deutschlandfunk radio: “The Spanish state is taking the loans, Spain will be responsible for them… There will likewise be a troika. There will of course be supervision to ensure that the program is being complied with, but this refers only to the restructuring of the banks.”
I personally struggle to see how this is workable, especially given the funding body for the banks is a sovereign entity. This sounds far more to me like “Trokia by-stealth”, but I will reserve final judgement until I see the MoU.
In the meantime there is a second problem that we know already exists. This from the ESM treaty:
Like the IMF, the ESM will provide financial assistance to an ESM Member when its regular access to market financing is impaired. Reflecting this, Heads of State or Government have stated that the ESM will enjoy preferred creditor status in a similar fashion to IMF, while accepting preferred creditor status of the IMF over the ESM. This status shall be effective as of 1 July 2013. In the unlikely event of ESM financial assistance following a European financial assistance programme existing at the time of the signature of this Treaty, ESM will enjoy the same seniority as all other loans and obligations of the beneficiary ESM Member,with the exception of the IMF loans
In other words, by accepting this loan Spain has just sub-ordinated all of its existing bond holders. Obviously, given the LTRO, many of these holders are Spanish banks but on top of the additional debt to GDP ratio this bailout pushes onto Spain (possibly up to 11% ) this again is a poor outcome for sovereign risk which is why we saw Spanish yields climb higher overnight against expectations of the opposite:
So, although, in Mariano Rajoy’s own words, there aren’t any additional requirements on the state due to this loan, the reality looks to be quite different. I hesitate to pass judgement given we haven’t yet seen any real detail of exactly what Spain is getting, but it would appear that this Spanish bank bailout has just pushed the sovereign closer to requiring full-blown assistance of its own.
They will, however, need to get in the queue:
Cyprus said Monday that it urgently needed European financial aid to boost its banks’ capital, a step that would make it the fifth euro-zone economy to seek help from the region’s bailout funds.
Cyprus Finance Minister Vassos Shiarly said the country’s need for an international bailout was “exceptionally urgent” in order for it to recapitalize its banks, and that the issue would need to be resolved by the end of the month.
According to several European officials, the size of any bailout would be unlikely to exceed €3 billion to €4 billion ($3.8 billion to $5 billion), a sum that wouldn’t strain the resources of the euro zone’s bailout funds. The economy of Cyprus—an island of 800,000 people—is one-sixtieth the size of the economy of Spain, which said over the weekend that it would seek European funds to recapitalize its own banks.
However, some European officials said the main impact of Cyprus’s request might be to send a further signal that contagion is spreading in the euro zone. Greece, Ireland and Portugal are all in bailout programs.