Guest Post: It’s Only PIG: Fears About Spain Are Overblown

Tyler Durden's picture

Submitted by JM

It’s only PIG:  Fears about Spain are Overblown

OTR bonds yields just don’t support the case that Spain is the “S” in the PIGS.  Spanish debt is higher than Bunds, but they are nothing like unserviceable. 

It makes more sense to think of EU sovereigns as junk grade: Greece, Ireland, and Portugal; middle tier credits with balance sheet stress that appreciably impact yields, like Belgium, Spain, and Italy; and credits like Germany and the Netherlands that benefit from derisking.

Q1 GDP grew .7% y-o-y.  Also, the CDS market shows an improvement in sentiment on Spain.

Spanish CDS, May 2010-tonight

Assuming 40% recovery, this spread is pricing in a 14% probability of a Spanish default in the next five years.  One shouldn't think of this probability of default as a classic probability derived from frequencies.  It is the view on default implied by aggregate buyers and sellers of Spanish government credit risk at the 5 year tenor.  This notion of implied probability “works” because it is the meeting place of willing buyer and seller at a given point in time.  It is nothing more than a market view of credit risk given the premium needed for a seller and the credit risk hedging needed for a buyer to both take the trade.  

There are other possible explanations that sentiment in this spread.  Possibly the CDS spreads reflect a certain large marginal buyers selling CDS to push down cash yields, acting to create a kind of fake-out.  CDS premium is cheap to OTR cash yields (see below).   Either way, the spread is an indicator of the the view of institutions with fast execution and informational advantage over most others. 

There are legitimate grips about the information content of these spreads, which I respect.  But CDS were created and function to address a basic business need that dealers have.  Dealers have an inventory of underlying securities on which they need to hedge credit risk.  The need became acute in the early 1990s because extremely low interest rate and liquidity policies from central banks altered the return distributions on bonds of all types.  These policies lower the first and second moments of the distributiion at the expense of much fatter tails that are best dealt with by hedging.

Politics Matters

The correlation between the Euro and Spanish credit risk shows that Spain is a domino too big to fail.  It is difficult to conceive of a situation where policymakers would say goodbye to their own jobs by permitting a default.  These are fundamentals that matter.     


It is doubtful that policy can actually stave off default, because liquidity provision is the limits of their arsenal.  However, liquidity policy can extend kicking the can down the road for a time.  The bottom line is cost of funding.  Once it reaches a threshold level, there is just too much pain and default becomes the politically acceptable option.  We are nowhere near funding costs that in Spanish government bonds.  If fact, the relative pricing of synthetic and cash makes for a compelling trade. 

Bottom line here is that one can use numbers and information to play the numbers, but the view you take is always speculative.

OTR Spanish 5Y Government Bonds, tonight’s quote

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Tulli's picture

Here are some facts that all Finns (and everyone else) should know about Portugal:

vote_libertarian_party's picture

So this is the Portugese way of begging Finland to not veto any bailouts?


What is the time line of when Finland would act?  Is there a showdown vote on the calendar yet?

Tulli's picture

The vote is on May 16th. By then the Finns will have said yes. Until then, the Portuguese will mock them as hell, knowing full well that they will be mandated to comply.

You may also have noticed that the interest rate that Portugal will pay is well below Greece or Ireland, and the package is lighter (and even still will be renegotiated).

Is it a coincidence that:

- The President of the European Commission (Barroso) is Portuguese;


- The Vice-President of the ECB (Constancio) is Portuguese;


- The very recently appointed Director for Europe at the IMF (António Borges),

Are all Portuguese?

Only if you believe in the tooth fairy.

Yes, the Finns will comply, Yes the bailout will be renegotiated later on, Yes this was yet again another form of saying "Give us the money or we will drop out of the Euro and your exports (53% of all Europe exports) will no longer be allowed in our waters.

The Paulson Bazooka revisited, Lisbon style.

Enjoy your weekend.

bank guy in Brussels's picture

Tulli wrote:

« Here are some facts that all Finns (and everyone else) should know about Portugal: »

That's a wonderful entertaining cultural survey of Portugal in six minutes of video.

Great ironic finale about how, in decades past, the Portuguese took up a massive collection for the hungry and cold people of Finland.


Canucklehead's picture

Don't you find that video embarassing for Portugal? I can't think of any serious country that would present it's "strengths" in such a way.

Maybe if Finland gave the old clothes back you could call it even....

Non Passaran's picture

What a waste of time. A bunch of useless information.

jm's picture

If I'm taking the "S" out, then I'm not going to dignify the inclusion of Italy.

bank guy in Brussels's picture

You're quite well-justified in arguing there is something different about Spain versus Greece, Ireland and Portugal -

This is indeed where the EU - ECB are drawing the line. Every resource is being used, and will be used, to hold that line. People I know in the relevant EU agencies are working late hours and weekends to make sure the previously bailed-out countries are ring-fenced. Germany is fully on board with the programme to save Spain within an intact euro-zone, even if in the long term there are restructurings (which would include the German and French banks).

JM - your yin-yang avatar, as well as being a classic evocative spiritual emblem, was also the symbol of North America's Northern Pacific Railway. Always wonderful to see it on the model and toy train locomotives and cars. (Look, e.g., at 'Northern Pacific' on eBay.)


ZeroPower's picture

"JM - your yin-yang avatar, as well as being a classic evocative spiritual emblem, was also the symbol of North America's Northern Pacific Railway." Any ideas behind the history/significance of it on a railway system?

Non Passaran's picture

People I know in the relevant EU agencies are working late hours and weekends to make sure the previously bailed-out countries are ring-fenced.

LOL.  And what exactly does that "work" consist of? Deciding (in secrecy) who will pick the tab?


The Gold Theory's picture

Have you looked at debt to gdp?  I saw an article on ZH referencing Greenspan's opinion that any country that breaches 90% debt to gdp is doomed recently... I tend to agree there and Italy has 120% debt to gdp, the only PIIGS with higher debt/gdp is Greece at 142%.  Am I missing something or are you assuming that current bond yields are properly pricing in the uncertain future?

Mentaliusanything's picture

And Japans Debt is 210% of GDP excluding the 4.8 triilion yen required to recover from its triple Hex.

Gross domestic product is not a determinate in bankrupcy.

Reggie has a complicated answer here -

But this might give you a cold shiver if you take the time to read it. It includes a video about China and how its GDP is so large but its ordinary people are so poor. Time to think about Gross Domestic Happiness (GDH) which some countries have in abundance

jm's picture

I look at public debt to GDP and external debt more than gross debt.

To me, these mettrci better address the issue of "can they roll the debt?"

Forget retiring the debt. It's about rolling debt whilst cutting operating budgets to sustainable levels. 

And don't think that I'm saying there is no pain coming for some of these countries... but default risk is overstated for them.

If the ECB/EU really has its mind to it, they have poweful tools to kick the can down the road.  A monetary authority can break the rules and print.  Given this directive, a prxoy can sell CDS on the debt, creating mechanism for spread compression and the appearance that everything is all compression and light.

That mechanism actually doesn't guarantee solvency, that is the tough work for Spain.  It is a question of their assessment of the benefits and pain, and their willingness to honor their obligations.  But it does put time on the side of the tail-risk killers. 

The whole idea of "Middle Tier" countries came from looking at the EU sovereign debt curves.  The curves for the periphery look a lot like C grade junk.  

Highrev's picture

I just responded to another of your posts down a bit and was reminded of this post.

It's about rolling debt whilst cutting operating budgets to sustainable levels. 

That's it in a nutshell, and cutting operating budgets to sustainable levels IS ENTIRELY FIESABLE in the Spanish case.

Cutting out the graft and corruption and getting public employees to actually work would in and of itself turn the situation 180 degrees. (That’s a caustic joke that is dead seriously based in reality.)

One of the similarities the Mediterranean countries do share is a very inefficient public service system ripe with corruption and vested interest. On a social-cultural level, my reading is that the Spanish as a people are ready to address that issue. My reading on Portugal is the same, but with much less emotional commitment. I think we could say that the Italians are interested in getting serious (especially the northern half), but, in this regard, this is where I think Greece finds itself as the odd-man-out.




kushmere's picture

I thought the problem with Spain wasn't so much its own finances, but rather how its finances were linked to Portugal and Ireland. 

It was my understanding that a haircut or default/restructure by Greece would ripple out to Ireland, Portugal, and Italy which would in-turn put additional pressure on Spain. 


Perhaps an expert can put it in perspective?


Reptil's picture

That, and the private debt and unemployment is Spain's bigger problem.

AgShaman's picture


had I seen your post i'd have kept my mouth (digits) shut

AgShaman's picture

Hadn't heard that one...but another that's been brought forth by others was that it had a very large unemployed group of younger people....also a real estate bubble that rivaled the US.

I haven't visited Spain...i'd like to...maybe when some of these countries get their **** together...I'll get back into travelling more.

bank guy in Brussels's picture

Whatever might appear from reading economics articles, in real life on the streets and in the countryside, Continental Europe is still the greatest achievement ever in human civilisation.

Don't hestitate to visit right now; sit in one of our relaxed cafés with a glass of wine or a beer, and and you will slowly start to realise why things here are 'all right' regardless.

And you may also start to see why many American gringos have picked up their marbles and quietly escaped here, and smacked themselves for not moving here much earlier.

FeralSerf's picture

The best ice cream and chocolates in the world.  No contest (except perhaps with a certain Roman chocolate ice cream maker).

Brussels is a wonderful city -- many good memories!

ZeroPower's picture

I've been trying to enjoy this "continental" atmosphere for about a year now, and i must tell you, theres nothing pleasant about having to pay my 4EUR coffee (well, its an espresso really, but the French dont know the difference) every morning. France is ridiculously overpriced (even compared to Germany!) and, as the French president might or might not have noticed, its being overrun by foreigners (think MENA) who come in to steal benefits and stay for free.

Western EU was the win years ago. Not anymore, unfortunately.

Bendromeda Strain's picture

Don't hestitate to visit right now; sit in one of our relaxed cafés with a glass of wine or a beer, and and you will slowly start to realise why things here are 'all right' regardless.

Arnold and Maria were filming commercials saying the very same thing for scroomed California. Cynical me, do I detect a trend?

Highrev's picture

The difference is that Europe isn't making commercials saying so and California is.


jm's picture

The problem with Spain has nothing to do with Greece and Portugal, although the latter could hurt Santander to soem extent.

The problem of Spain is NPLs at the Cajas, the national savings banks and residential lenders.

They have about E120 billion in performing loans, some could sour.  They have E28 billion in NPLs already written-off/socialized.  They have about E50 billion in reserves.  Spanish gov already has E20 billion provisioned for losses (no need to borrow this, already done).

This isn't bad.  

There will be ripples which will stress the middle tier, but they won't break.

Re-Discovery's picture

The article makes the obvious mistake of looking at Spain as if it exists independent of the Eurozone.  It is not whether Spain will fail.  It will.  The only question is WHEN the ENTIRE eurozone will fail.

The writer employs classic bubble thinking, i.e. the thinking displayed by people who live in them.  To say that charts say everything is OK in Spain disregards any number of unknowable event risks that exist in highly inner-connected economies of the rest of the eurozone.

jm's picture

I'm certainly not saying that I am right and everyone else is wrong.  Let's try to be civil to each other in this little corner. 

Spain going back to a Peseta and Germany goes back the Dmark, is unlikely and a separate issue. The spread is the spread.  Spanish debt is nothing like Greece.

Re-Discovery's picture

Aside from this being "Fight Club" which I think an artifice too often relied upon by posters here simply to be rude, I think you are mistaking critical for un-civil.  I was being the former.

Thank you for taking the time to gather the information and post the article.  I do think the issues in Spain are far under-reported and ill-considered.

jm's picture

Thx back.  I'm just sick of how this site sometimes devolves.  You know what I mean.

Re-Discovery's picture

I am curious, why do you see a return to national currencies unlikely?  Didn't these countries have their own currencies for hundereds of year prior to the eurozone 'experiment'? 

Aren't the daily fails in the eurozone making change of the system increasingly more likely?

jm's picture

There's no benefit in dropping the euro for anybody that matters yet. 

Re-Discovery's picture

Germany is the only one that 'matters'.  And they will  make the decision easy for everyone soon enough.  Then the whole issue of foreclosure will make the concept of the 'euro' among the most loathed in the history of the continent.  Right up there with fascism and the imperial (not modern) Catholic Church.

gorillaonyourback's picture

remember that meeting between germany russia and china about 6 months ago?. it was basically in private and word was they were talking about making their own union.  Germans are not that stupid to try and keep a debt ladened union together with out preparing for an exit plan.

falak pema's picture

move to Barcelona and buy cheap flats...

AG BCN's picture

good luck with that one. Let me know how it works out.

Seasmoke's picture

its all Systemtic

Franken_Stein's picture


Germans want a ban on CDS, since it is paper fraud, courtesy of Blythe Masters.

It serves only one party, the banks.

Why would one think that an instrument, invented by a notorious liar and thief would serve any greater common good ?


Banks do not create value.

They are there for one purpose only:

To steal from, to rob from, to expropriate, to deceive hardworking people all over the world who create the wealth of this world with their hands and their minds.


So it's time to abolish the pen pushers and paper shufflers, the tie wearing chair-farters, the losers in pinstripe suits.


Daedalus's picture

Yeah right.

Because all of the Spanish banks are solvent and liquid?

Ireland is in trouble because it acknowledged its banks were bust and guaranteed to fix them.

I reckon that if Spain tried to do the same it would also have some BIG problems.

Do you know what percentage of the loans to property developers made by banks have been written off?

How about loans secured on undeveloped land which will now remain undeveloped for decades?

Once these problems are resolved, I might start to believe that there are no problems in Spain.

AG BCN's picture

agreed, everything and I mean everything is covered up. In Southern Europe it's a way of life.

topcallingtroll's picture

They might be able to keep it covered a long time.

Like cognitive dissonance once said." If you are one year early you are a genius. If your predictions are five years early you are a nut."

AG BCN's picture

They are hanging on as long as they can, waiting/praying for an upturn, but we are years away from that. In 1,2 or 5 years from now it will go down. I have been watching the real estate market in Barcelona and the surrounding areas very closely. Nothing has moved for 3 years, tens of thousands of unsold or incomplete properties. The banks are buying the distressed properties so they don't show up as a balance sheet loss, they are still valued at 10 x average salary. Nothing is going to move even at the current low interest rates. I can't imagine what will happen when JCT puts the rates up to +4% to curb inflation.

Highrev's picture

Goggle "world's safest banks"

What do you come up with? The first U.S. bank is 30th on the list of the top hit!

Four Spanish banks are ahead.

The top 9 are all European.

I've been saying for a long time that Europe has problems, there's no denying that, but the blow-out-of-proportion presentation of such by the U.S. mainstream press is nothing short of a blue herring.

. . . aimed at whom? . . . for what purpose?

It certainly gives breathing room to the USD as the European boogieman is trotted out from time to time.


jm's picture

See above.  The Spanish government is being very transparent here, if optimistic in their projections.

Construct's picture

Spain is a one of the big countries in Europe with 46m citizens and their main problem was and is high unemployment. But when it comes to national debt (60%) and budget deficits (11) I would say they are not any worse then any other countries. Spain's problem is that to few people pay taxes and to many people are dependant on the state. Like that is not the case in every single country on this planet?

Hugh_Jorgan's picture

Eventually, the EU will fall apart as fewer and fewer member states have the stomach for bailing out these imbeciles over and over again. The big nations won't be the first to fall, but they WILL fall eventually as their are unable to finance their existence.

I see ZERO prospects for the future in today's economic fundamentals. The consumer ecomonmy is on it's back because the worlds largest consumer body is broke (US) and will not see economic grow anytime soon. I can only see a system that will have to reset after a series of collapses.

Someone please explain what I've missed here..

Construct's picture

Germany which benefited the most from EU at the expense of everything else should pay up. If they go broke in the process is not my business or anyone else's either. They wanted EU and they have dominated every other country in EU like Adolf Hitler would have. So the cost is on them. I refuse to pay or contribute in any way shape or form.

magpie's picture

The price of Empire; the last time for Spain it was losing all of its manufacturing and 30 % of its population, so perpetual bankruptcy and a lower living standard are a lighter burden (that is, already before actually losing your empire).

jm's picture

You have too much fear and not enough hope.  It creates a tunnel vision that doesn't enable you to look outside the box.