Experts Speak: EconMatters (By Mindful Money via QFinance)
On Friday, in perhaps an example of the strategy of a good day to bury bad news, Spain announced some changes in its position on bank bailouts. Coming around an hour or two before the keynote speech of US Federal Reserve chairman Ben Bernanke, it did not get the attention it deserved except in one area. Longer dated Spanish government bonds fell in price as her ten-year yield rose by more than a quarter of a point to 6.86%.
What did Spain announce?
There is to be a change in the Spanish bank rescue mechanism called the FROB which is to become a “bad-bank”. This is quite a change in itself as before the Spanish authorities had loudly proclaimed that a bad-bank was not going to be necessary in Spain. For those unfamiliar with the concept of a bad-bank it is an institution which will take the weaker assets off the books of the Spanish banks. In essence, those that represent airports which never opened and empty apartment blocks and of course the associated loans.
So we are seeing the usual type of clean-up which is another example of the privatization of profits and the socialization of losses. This is in spite of claims by Spanish ministers that this will show a profit. You see we know what happens here as we have the example of the Irish bad-bank called NAMA which was established with Irish ministers making exactly the same claims. The reality is that, according to the Irish blogger Jagdip Singh, it has so far lost just under 25% on its overall holdings.
As we survey the Spanish banking system, we see one where the size of property loans that are to use the euphemism “problematic” is around 180 billion euros. Or rather that is the estimate, so far as experience has told us that closer examinations tend to see such numbers rise. If we recall Bankia’s situation from the spring the estimate of the required bailout doubled in a fortnight.
Another potentially unstable lifeboat:
The FROB itself is to be expanded to a capacity of 120 billion euros to cope with the requirements outlined above. This is up from the previous 90 billion Euros. All well and good until we recall that it actually only had a capital of 15 billion euros which as I pointed out on the 25th of May.
This leverage capacity can be increased up to 6 times with the approval of the Ministry Of Economy and Competitiveness. So 15 billion times 6 gets us to the 90 billion. However, as I pointed out then dealing with likely losses via a leveraged institution has an obvious problem. What if the losses turn out to be larger than the capital base? We await to see how the Spanish government will back the new increased FROB capacity.
More fundamentally exactly how will leverage solve problems which were created by an excess of leverage? Wasn’t the European Financial Stability Facility supposed to be backing this?
Exactly, but so far we seem to be lacking any real details of what will happen here apart from the original promise of up to 100 billion euros of bank aid. Even the 100 billion Euro capacity compares unfavorably with the new 120 billion FROB capacity.
I discussed the problems which led to Bankia’s nationalization back on the 8th and 25th of May. It published its latest figures after trading had closed on Friday and they showed a further loss of 4.4 billion euros. To stop it collapsing the FROB has stepped in but it is much lighter on the detail of how much this will cost, than hyperbole.
The restructuring will guarantee the solvency and long-term viability of BFA/Bankia Group. Really? One factor that seriously questions such hype is the way that in spite of all the state support Bankia has been bleeding deposits. She lost some 12.8 billion euros (10%) in the first six months of the year and we know that for Spanish banks overall the rate of deposit loss increased in July.
Spain’s fiscal deficit is off track:
On Friday Spain’s Treasury announced that Spain had borrowed some 48.6 billion euros or 4.6% of its Gross Domestic Product in the year to July. This was more than the deficit target for the year but this has been revised several times now and is 6.3%. So the new deficit target looks under pressure to say the least and it was only set on August the 8th! Also the announced figures only cover the central government and we know that other porblems lie in Spain’s troubled regional government system. Even if we did not know this we would have been reminded by the fact that Valencia, Murcia and Catalonia have called for more government help in the last fortnight.
If we compare these numbers with last year’s we see that Spain’s central government fiscal deficit is running 1% of GDP higher than last year. Yet again proclaimed austerity seems to mean an increase in a deficit rather than a fall. As of the beginning of this month the austerity noose has been tightened by an increase in Value Added Tax to 21% and other changes but the past tax increases had led to a revenue decrease of 1% in the year to July as the economy weakened.
How is Spain’s economy doing?
On Friday I reviewed the latest retail sales figures for Spain and they showed a fall of 7% on the year before at what you might consider to be something of a peak (summer) period. Today saw the release of the most up to date data we get as the purchasing managers report for August was released.
The Spanish manufacturing sector remained in contraction in August as output, new orders and employment all continued to decrease. That was the sixteenth fall in a row and whilst the rate of fall moderated slightly from 42.3 last month to 44 this on a scale where 50 represents unchanged it is still a substantial decline. And the detail remains a concern. A further decline in new orders was seen at Spanish manufacturing firms (…) A further sharp decline in employment was recorded in August. There was little sign of relief via possible exports as the figure for the eurozone overall also showed a contraction coming in at 45.1 for August.
Spain’s yield curve is getting extreme:
I discussed at the beginning of this article the ten-year yield in Spain which is 6.8%. My point about an extreme yield curve is made by the fact that her two-year yield is 3.6% or 3.2% lower. It is not unnatural for the longer dated yield to be higher it is the size of the gap which is the issue. Why is it there? Because investors believe that the head of the European Central Bank Mario Draghi made a promise before the summer holiday to support shorter-dated Spanish bonds. Accordingly they have rallied and are awaiting the details of such support on Thursday when the ECB meets. There is plenty of scope for disappoinment.
If Spain is tempted to start funding herself with shorter-dated bonds to take advantage of cheaper funding rates there is a problem as the bonds will need to be refinanced relatively quickly and she becomes more vulnerable to bad news.
We see so many familiar themes represented today. My financial lexicon now has so many entries under the definition of austerity where it has come ever more to mean an increasing fiscal deficit. It also needs a subsection where it seems to involve ever higher taxes as public spending cutbacks prove elusive. Added to this we see that Spain’s new efforts to tighten the noose which began on Saturday are likely to plunge her even further into an economic depression. I fear for the last part of 2012 and the beginning of 2013.
On the other side of the coin we see the ECB presented as a saviour and indeed it does have some powers. The problem is that it can help Spain’s government to issue debt more cheaply if it chooses too but this does little to help the underlying economic problems and poses questions for its own future. With one of its main interest-rates already at zero and a balance sheet of approximately 3 trillion euros we can see that even enormous monetary stimulus efforts are not helping the Spanish economy much.
Any solution is in the hands of politicians in the eurozone which requires either closer co-operation or a break-up. But instead we seem likely to see more muddling through where on the evidence so far everything gets worse while politician’s claim success.