On April 11, 2011, then Spanish finance minister Elena Salgado declared: “I do not see any risk of contagion. We are totally out of this.” A little over a year later, Ms. Salgado and her party are no longer in power and Spain is well and truly in it.
After weeks of prevarication, Spain has applied for a bailout for its banking system. Sorry, it’s not a “bailout.” As Spanish Finance Minister Luis de Guindos clarified: “What is being requested is financial assistance. It has nothing to do with a rescue.”
It is quite a turnaround. On March 30, the Minister stated: “We are convinced that Spain will no longer be a problem, especially for the Spanish, but also for the European Union.”
Prime Minister Mariano Rajoy’s attempts to maintain confidence a few days later were confusing: “To talk about a bailout for Spain at the moment makes no sense. Spain is not going to be rescued. It’s not possible to rescue Spain. There’s no intention to, it’s not necessary and therefore it’s not going to be rescued.”
But regardless of what it is called, the bailout may not work.
The amount of €100-billion ($125-billion U.S.) or more – depending on the independent assessment of the needs of Spanish banks – may not be enough.
On the surface, it appears close to three times the €37-billion the International Monetary Fund says is needed. The capital requirements of Spanish banks, though, may turn out to be much higher – as much as €200-billion to €300-billion. The IMF assumes only the smaller savings banks (the cajas) will need help. In reality, the larger Spanish banks may also require capital.
Spain’s banks have more than €300-billion in exposure to the real-estate sector, mostly through loans to developers. Around €180-billion of this is considered problematic by Spain’s central bank. Estimates suggest that there are about 700,000 vacant newly built homes. But including repossessed properties, the total could be as high as one million or even more.
At current sales levels, it will take many years to clear the backlog, which will be compounded by more properties being completed and coming on to a depressed market. Housing prices have fallen by 15 to 20 per cent, but are forecast to decline eventually by as much as 50 to 60 per cent. A severe recession and unemployment of 25 per cent means that losses on the more than €600-billion in home mortgage loans are also likely to rise.
The proposed bank financing also does not include any provision for writedowns on holdings of sovereign debt. Local banks are estimated to hold more than 60 per cent of Spanish government bonds outstanding.
The bailout will come with no conditions (at least none visible), which creates its own problems. The lack of conditions may lead to Greece, Ireland and Portugal seeking relaxation of the terms of their own assistance packages. The lack of conditions also prevents the International Monetary Fund from contributing.
In an opinion piece in the Financial Times, Jin Liqun, chairman of the supervisory board at China Investment Corp., pointedly noted the contrast between the treatment of European and Asian countries.
“Viewed from China, the management of the euro zone debt crisis offers a stark contrast to the handling of the 1997-98 east Asian crisis. In that episode, Thailand, South Korea and Indonesia were all forced to implement tough austerity programs imposed by the International Monetary Fund. ... Unlike many of today’s Europeans, the people of east Asia did not have the luxury of large relief funds from outside their countries. The people had to tolerate hardship. ... In a poignant case, the Korean people contributed gold and household foreign exchange to the government to help ease fiscal pressure.”
Future international support, either bilateral or through the IMF, may be difficult.
The funds will come from either the European Financial Stability Fund (EFSF) or the still to be approved European Stability Mechanism (ESM). Since 2010, the euro zone has committed €386-billion to the bailout packages for Greece, Ireland and Portugal. In theory, the EFSF and ESM can raise a further €500-billion, beyond the commitment to Greece, Ireland, and Portugal, allowing them to contribute the €100-billion for the recapitalization of the Spanish banking system.
The EFSF-ESM also assumes that it “can leverage resources.” The reality may be different.
For a start, Finland has indicated that it may seek collateral for its commitment, an extension of its position on Greece, which the European Union ill-advisedly agreed to.
As Spain could not presumably act as a guarantor once it asks for EFSF-ESM financing, Germany’s liability will increase further to 33 per cent from 29 per cent. France’s share increases to 25 per cent from 22 per cent. The liability of Italy, which is in poor shape to assume any additional external financial burden, rises to 22 per cent from19 per cent.
The EFSF’s double-A-plus credit rating may now be reduced. Irrespective of the rating, the EFSF and ESM will have to issue debt to finance the bailout. Support for any fundraising by these mechanisms is uncertain. Commercial lenders have been reducing European exposure. Emerging-market countries with investable funds lack enthusiasm for further European involvement. Lou Jiwei, the chairman of China Investment Corp., the country’s sovereign wealth fund, has ruled out further purchases of European debt: “The risk is too big, and the return too low.”
The bailout also fails to address fundamental issues. The funds will be lent to the Spanish government, probably its bank recapitalization agency FROB, rather than supplied directly to the banks because of legal constraints. This will increase Spain’s debt level by 11 per cent of GDP.
The transaction will do nothing to reduce the country’s overall debt level – exceeding 360 per cent of GDP before this transfusion. Spain’s access to the capital markets and its cost of debt are not addressed. The last auction of Spanish government bonds saw a yield around 6.5 per cent per annum, with the bulk of the bonds being purchased by local Spanish savings banks.
Spain and its banks also face pressure on their own ratings, which are now perilously close to becoming non-investment grade. The bailout may actually adversely affect the ability of Spain and its banks to obtain funds. Commercial lenders are now subordinated to official lenders. Based on the precedent of Greece, this increases the risk significantly, discouraging investment.
The European Union has stated the belief that this intervention will help the supply of credit to the real economy and assist a return to growth. This optimism is unlikely to be realized. Restoring the banks’ solvency will not result in an increase in credit. The capital will allow existing bank debts to be written off. Spanish banks have limited access to funding. They are heavily reliant on the European Central Bank for money – which the assistance does not address.
But even if the flow of credit improves, it would merely allow half-finished buildings in the middle of nowhere and with no obvious buyers to be completed, compounding the overhang of unsold property.
Given that Spain’s problems were caused by a debt-fuelled property boom, more of the same does not seem to be a sound solution.
Slowing or shrinking European and Spanish economies are also likely to limit any recovery and improvement in Spanish employment and investment. Mr. Rajoy, the PM, made the quixotic claim that the assistance was a victory for Spain.
Opposition Socialist leader Alfredo Pérez Rubalcaba retorted that “the government is trying to make us believe we have won the lottery.” Spain will need to win the lottery – probably its own El Gordo (the big one), the world’s biggest lottery – if it is to avoid a full-scale bailout, which may be beyond the capacity of Europe, economically and politically, to undertake.
Satyajit Das is author of Traders Guns & Money and Extreme Money.