As firewalls in global financial crises go, the Spanish bank bailout sketch of a plan is pretty thin stuff
The euphoria that someone did something quickly wore off today as global financial markets studied what the Spanish “pre-request request” does and doesn’t do for solve the Spanish and euro debt problems. The Spanish IBEX 35 index, which had been up by as much as 5.9% early in the session, closed down 0.54% for the day.
The list of what Spain’s decision to tell EuroZone finance ministers that it will request up to 100 billion euros ($125 billion) to recapitalize Spain’s troubled banks will do is relatively short: It would give Madrid access to enough capital so that FROB, the country’s bank rescue fund, could make sure that the Spanish banks most exposed to bad loans from the country’s property and corporate sectors won’t run out of capital. All of Spain’s banks face more write downs in their loan portfolio as they mark the value of these loans to market. The country’s most troubled banks can’t raise money in the financial markets to make up the hit to their capital that will come from those write-downs. Saturday’s deal would make sure that those banks could access capital from a EuroZone rescue fund through FROB and the Spanish government.
The hope is that this deal will slow the flow of money out of Spain’s banks as depositors decide that their money is reasonably safe. (My guess is that it will slow but not stop the flight to safety.)
The deal is also supposed to reassure the financial markets that Spain and the EuroZone are prepared in case the June 17 Greek vote leads that country out of the euro. So far, the market doesn’t seem overly impressed. The price of 10-year Spanish bonds fell today driving the yield to 6.52%, an increase of 0.3 percentage points.
The list of what the deal doesn’t do is much longer.
It doesn’t break the negative cycle where the Spanish government borrows to fund Spain’s banks and then Spanish banks use the funds to buy Spanish government bonds. That practice has supported the price of Spanish bonds at a time when there aren’t a lot of non-Spanish investors looking to buy Spanish government debt, but it has also increased the exposure of Spanish banks to losses when the price of Spanish government bonds falls.
It doesn’t produce a peso’s worth of growth for an economy that desperately needs growth.
It doesn’t reduce Spain’s debt to GDP ratio. In fact it adds to it since the money to recapitalize Spain’s banks will flow through Madrid and show up as a liability on government balance sheets. If Spain takes the whole 100 billion euros, it would add about ten percentage points to the Spanish debt to GDP ratio. That ratio would then peak at 95% of GDP in 2015, up from 68.5% at the end of 2011.
And it doesn’t make non-Spanish investors more willing to buy Spanish government debt. In fact it may make them even more leery. The announcement this weekend left it unclear whether Spain would get the money to recapitalize its banks from the existing European Financial Stability Facility or the new European Stability Mechanism that is scheduled to go into business in July. It makes a huge difference. Borrowing from the ESM would be senior to obligations to current holders of Spanish government debt meaning that the ESM would get paid back first in case of a credit event. Borrowing from the EFSF doesn’t have the same superior seniority.
Reviewing the weekend’s announcement Standard & Poor’s said that doesn’t see any reason to change its opinion on Spain’s government debt. Fitch Rating’s dropped its rating for Spain’s two biggest banks Banco Santander (STD) and Banco Bilbao Vizcaya (BBVA) today citing worries about the effect of the recapitalization plan on the credit worthiness of the Spanish government. After the downgrade to BBB+ from A, these two banks carry a higher credit rating that the BBB- rating of the Spanish government.
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