Spain: Not waving but drowning - bailout tomorrow


Spain began this week in bailout territory. Despite the increasingly shrill warnings of imminent catastrophe from Madrid, the battle of wills between the Spanish capital and Brussels, Berlin and Frankfurt has managed to avert the hour of judgement thus far. But can they achieve the aim of preventing the fall of Spain before the second Greek election?

Yesterday’s auction of Spanish debt bonds was seen as the likely crunch point coming into the week. Spain started from the position of being past the 450 bps technical limit set by the main European clearing house for the maximum spread between its 10 year bond yields and those of a basket of AAA grade Eurozone 10 years. Being in breach of this limit for over 5 working days was the technical mechanism that brought about the Irish and Portuguese bailouts in the past two years. The simple version is that banks holding national bonds need to pay a charge to the clearing house, which acts as guarantor, to temporarily swap the bonds for a cash equivalent. This charge is called the “margin call” and has to be vested with the clearer. If the clearer raises the margin call from the basic 5% to 15%, then all banks with these instruments loaned out for cash, suddenly need to find the extra cash to pay the increased margin. If all their money is in national bonds, then they have to sell some at any price to pay the margin call. The bond prices go down, the ratings agencies lower their ratings, the clearing house increases the margin again, creating the “death spiral” that forced Ireland and Portugal into the Troika bailout - not because the state was bust at the time, but because their banks were days away from cash flow collapse.

Yet, although it was 6 working days since Spain crossed the technical boundary into the “death zone” this Monday, the London markets were closed for the ignomious monarchist Jubilee. Both for Monday and Tuesday. By Wednesday when the London markets re-opened, the spread had crept down to 447 bps, and after nine calendar days in the red, Spain was temporarily in the clear again. Yet when Cristóbal Montoro, the Spanish Finance Minister said in a radio interview on Tuesday that Spain was shut out of the capital markets, he was in fact only telling the truth at that time. Although he got slammed for it, it seems his words had the desired effect, as by the time the markets opened the next morning, the dark arts practicioners in the ECB had worked their magic, even if only temporarily.

Certainly at this stage, it is an open secret that the only buyers for Thursdays Spanish debt auction are the very Spanish banks who are at the mercy of the state for their continued existence. It also seems likely (figures are hard to get) that the bulk of the Spanish banks holdings of sovereign debt are now exchanged directly with the ECB for ready cash, rather than the open repo market. Even so this week has seen a lot of pretty high level phone calls, and not just between the European players, but a G7 level phone call on Wednesday. Media reported some surprise on the Japanese representative reporting that the Greek exit (or Grexit in the recent, ugly, financial neologism) was not discussed. Presumably because Spain was the main topic of conversation.

The fact that Spain, the 4th largest EU economy, was always “too big to bail” on the same terms as the “3 little pigs” of Portugal, Ireland and Greece, with the existing bailout funds (EFSF & EFSM) has long been an accepted part of the Eurocrisis political landscape. Now that Spain is firmly in bailout territory, the scrap over what happens next has got pretty heated. Germany wants to avoid the full costs of a full bailout of the Spanish state as a whole, for which there are insufficient funds at the moment, but it still wants to impose same strictures on Spain, of Troika rule via “Memorandums of Understanding”, as imposed on the 3 little pigs, but in return for only the money needed to rescue the Spanish banks. The Spanish government is understandably not a fan of this plan. Instead they want the Troika to provide money directly to the bank rescue fund (the unfortunately-named FROB - Fund for Orderly Bank Restructuring), without imposing direct economic rule on the state - or making the state take the costs of the bank bailout onto the sovereign debt balance sheet, as Ireland and the others have already done.

Naturally, if the “bailout-lite” plan went ahead before the second Greek election on Sunday after next (17th June), then the three little pigs will realise that the ruination of their countries to pay for the local bank bailout is a case of one law for the little guys and another for the big fellers like Spain. This manifest injustice could only strengthen the arguments of the Greek anti-austerity parties that the Greek deal is unfair and could be renegotiated without leaving the Eurozone. “We want what Spain just got”, would be a powerful slogan. Hence the attempts in the megaphone diplomacy in the media this week that a decision on such a plan would have to wait until after the reports from two investigations currently underway into the true solvency state of the Spanish banking system. The first of these, by the IMF, is due to report on Monday. The second, by external Eurostat investigators commissioned by the Spanish state at the time of the Bankia bailout, is not due to report until June 20th - a date conveniently after the Greek election and nicely timed for the start of the G20 meeting in Mexico, where Spain, presumably, could throw itself on the mercy of the current world crisis management council.

But the news this Friday morning is that it is looking like the hopes of delaying the bailout until then, are fading. From this morning, Reuters reported that a conference call of Euro Finance ministers is scheduled for tomorrow (Saturday) morning, after which Spain will annouce its bailout. The story has since been corroborated by a number of other sources, while still being vehemently denied by other Spanish government sources. Irish and Portuguese observers will ruefully recognise the pattern of ever-increasing denials that a bailout is about to be annouced as the sign that it is imminent. The game, it seems, is up.

Whether the bailout tomorrow is the full unconditional surrender to the tender mercies of Troika rule, as Germany originally intended, or the “bailout-lite” option of the EFSF funding the FROB directly, with no strings attached, as Spain wants, or some kludge between the two, we will find out in the next 24 hours it seems. Whatever the final shape of the deal, it is bound to raise questions over the current punitive regimes being visited on Ireland, Portugal and Greece. Watch this space...