Newedge: Spanish People May Regret This Bailout

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Tyler Durden's pictureSubmitted by Tyler Durden
on 06/11/2012 07:26 -0400

And another bank does a book report on our Saturday post explaining the Spanish bank bail out. At this point, it should be all too clear how Spain’s only solution to being in a very deep hole is to keep on digging.

From Newedge’s Nicholas Hasting

  • Cost of Spanish funding may yet rise even more
  • Subordination of bond holders under ESM rules is an issue
  • Reaction in Ireland and Greece not helpful to yields

Spanish banks may be off the hook for now, but the Spanish people aren’t.

The level of sovereign debt has just been increased but the ability of Spain to fund it hasn’t.

Just look at the market’s reaction to the weekend’s events in which Spain got the European Union to promise to provide EUR100 billion of loans to refund its financial sector.

On the surface, the package all looks like manna from heaven.

Spanish banks get the money they need to cover their gargantuan mortgage losses and stay afloat and the Spanish government, by not seeking a sovereign bailout, escapes the imposition of more austerity measures that the other bailout candidates, Ireland, Portugal and Greece, were forced to undertake.

Prime Minister Mariano Rajoy is certainly trumpeting the package as a major victory for Spain.

So why has the cost of funding 10-year money fallen by only 13 basis points, leaving yields still at a crippling 6.07%?

And why has the euro itself only gained about one and a half cents on the news?

Because now, sovereign Spain may be more exposed than it was before.

Part of the problem is the package itself.

The other part is how the rest of the euro zone reacts to it.

Although Spain may have preferred for the money to paid direct to the banks, Brussels, or maybe one should say Berlin, insisted that the funds be provided to the government for distribution through its Fund for Orderly Bank Restructuring.

This means that it is the state, not the banks, that is responsible for the debt and that the country’s debt-to-GDP burden could be pushed as much as 10% higher if all the funds are used. Instead of peaking at 82% of GDP in 2013, the ratio may now continue rising as far as 95% of GDP in 2015.

With the economy still expected to shrink by as much as 2% this year and tax receipts likely to decline in a similar vein, Spain is only likely to get relief unless its funding costs decline significantly.

And this may not happen.

At the moment, it remains unclear whether the loan will come from the European Stability Mechanism, which comes into effect next month, or from the existing European Financial Stability Facility.

If it is the former, creditors of the new loan will take priority if there is any default and existing holders of Spanish bonds would find themselves at the back of the queue.

This is hardly likely to encourage investors to continue buying Spanish bonds and the country could yet find that its funding costs remain high or even climb higher.

High yields could also continue to be a problem for Spain because of the response from other peripheral debtors to what is being seen as preferential terms being given to Spanish banks.

Ireland has already expressed its displeasure and is demanding that Brussels provide Irish banks with a similar deal retroactively.

However, it could be the impact on Greece that is most damaging to Spain. The country’s left-wing Syriza Party, which is campaigning ahead of elections on Sunday on a ticket of rejecting the terms of bailout, sees the Spanish deal as justification as to why Greece should refuse to accept further austerity.

This could increase the chances of a left-wing victory on Sunday and raise the risk that Athens will eventually be forced to leave the euro.

The general withdrawal of investors would not only leave the single currency floundering but it would mean even higher funding costs for peripherals and the Spanish people would find that the added burden of bailing out Spanish banks has fallen on their shoulders.

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