After weeks of denying the need for a bailout, and numerous market and financial manipulations, the Spanish government has finally officially requested assistance from the European Union.
Markets seemed to breathe a sigh of relief after the EU Ministers gave a favorable nod, which is hard to believe, any first year business student could have forecast this result, sure Spain tried to find underhanded methods of securing financing, using backdoor handshakes and sneaky methods, then last week the Spanish Prime Minister laid out his terms, No intervention, no austerity, no supervision and no explanations just give me the money, he demanded. That was met with a laugh I am sure Angela Merkel, smiled at that one. In the end Germany is ending up in control and with the final say in just about everything.
Back to our first year business student, just the sheer size of Spain, the eurozone’s fourth largest economy is enough to rattle markets and with their banks failing, is quite obvious what they had to do. Markets quickly regained their composure after bailouts were put together for Greece, Ireland and Portugal. But these are small players in a big sea, especially when compared to Spain, which is nearly twice as large as Greece, Ireland and Portugal put together.
Secondly, because Madrid was unable to win the political battle over the terms of the bailout, Spain’s debt burden looks set to increase by 20 per cent.
In the past few months, Span, with French support, has argued vehemently that the money from the eurozone bailout fund should be pumped directly into the troubled banks. But Berlin flatly refused to accept this approach. As a result, the eurozone bailout money will be funneled into Spain’s bank restructuring fund (known as FROB), which will in turn inject extra capital into struggling banks.
But because FROB is a Spanish government instrumentality, the cost of the rescuing the Spanish banks will be added to the €559 billion in debt already sitting on the central government’s balance sheet ( as it should be) and this is hardly likely to reassure the investors that Spain needs to fund its budget deficit, which is expected to come in at more than 5 per cent of GDP this year.
Investors will also be concerned to find out whether the money for the Spanish bank bailout is coming from the existing €440 billion bailout fund, or from the new €500 billion bailout fund, which is due to start operating next month.
The problem with this is that the ESM has yet to be ratified by Germany, whose parliament said previously it is sternly against allowing the ESM to fund a direct bank bailout, something which just happened. Thus, the successful German ESM ratification vote, whenever it comes, and which previously was taken for granted, now appears to be far more questionable.
Which leaves the EFSF. The problem with the EFSF is that there is about €200 billion in uncommitted funds. And this includes the Spanish pledge of €93 billion, which we can only assume is now officially scrapped.
Investors could shy away from buying Spanish bonds if the money comes from the new bailout fund, because loans from this fund have a higher ranking in terms of repayment than other Spanish debt.
But, even more importantly, investors will be worried that the latest Spanish bailout is merely reinforcing the doomed dynamic between debt-laden governments and troubled banks that lies at the root of the eurozone’s problems.
In some instances – such as Ireland – government balance sheets have been blighted by the cost of rescuing reckless banks.
In other cases – such as France – banks are under extreme pressure as a result of their decision to load up on the bonds of debt-laden countries such as Greece.
The latest €100 billion bailout of the Spanish banks will do little to arrest this downward spiral. Germany’s decision to force Spain to pick up the tab for bailing out its troubled banks means that market confidence in Spain will remain fragile. And this will continue to weigh on the Spanish banks, which hold massive portfolios of Spanish government bonds.