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On Spain's "Self-Reinforcing" Collapse And Why It Will Get Much Worse Soon
With bond spreads in Europe refusing to slow down for the Thanksgiving holiday (unlike the US, Europe will be open through the end of the week), and both Portuguese and Spanish spreads jumping to fresh records, with Spain nearly approaching the bailout threshold of 5%, it appears that the market has now pretty much skipped Portugal whose insolvency is a given, and has commenced the "pack of wolves" thing on Madrid. Expect to hear many accusations that CDS traders, and their naked shorting, is the spawn of satan any minute now, and for CDS trading limits to be imposed imminently (not to mention LCH hiking Portuguese and Spanish margins as early as today), even though as we have demonstrated repeatedly in the past, it is all cash bond sellers who are driving the price down. Nonetheless, it is a fact that "price action is now self-reinforcing" - what this means for Spain and for Europe is explained by Goldman's Francesco Garzarelli. Note that this is only a small part of the story. As Zero Hedge discussed first in early July, a far biggest systemic threat is what is happening (or rather, not happening) in the mortgage space, where just like in the US, Spanish Cajas continue to misrepresent the "phantom" bad debt on a national level, however unlike the US and the nationalized GSEs, there is no sovereign backstop to a nation full of delinquent mortgages. Back then the Stress Test farce brushed this biggest risk under the rug. Now that reality is back, this topic will soon come back with a vengeance.
Spain in the Spotlight
With no specific new local macro information, the market’s focus has turned to Spain, where 5-yr CDS broke above 300bp, taking out the highs reached in June. As we highlighted in our note this Sunday commenting on the Irish rescue package, this was fairly predictable. Investors have long been concerned about the potential unrecognized property market losses in the Spanish non-listed banks, and the resulting contingent liabilities for the public sector, and the latest twist of events in Ireland has promoted comparisons.
Undoubtedly, there are several areas of weakness in Spain to point to. Unlike in the ‘core’ countries, Spanish industrial activity has slowed in September, and the improvement in the trade balance appears to have stalled. The EUR 99bn scheme for voluntary recapitalization of banks (FROB) remains largely un-tapped, and its eventual activation will weigh on public sector issuance (2011 gross government bond supply is in the ballpark of EUR 130bn). Finally, the European mutual support framework continues to appear to us as inadequately capitalized to deal with potential credit problems of the size of the Spain.
Against this background, one cannot rule out the possibility of a further escalation of tensions as the price action becomes self-reinforcing. The fact that we are approaching year-end does not help, as the appetite to bear risk is gradually declining. Nevertheless, our view remains that the support offered to Ireland (which will possibly be extended to Portugal), goes a long way towards addressing the source of EMU credit tensions. We also continue to believe that the price of Spanish sovereign risk is increasingly diverging from its fundamental value. In support of this stance, we note the following.
- The Spanish economy is large and diversified, with relatively deep capital markets. Purchasing managers indices for November point to ongoing recovery in the core economies, and Spain should also be a beneficiary given its integration with its main trading partners (for reference, around 60% of Spain’s exports goes to the rest of the Euro-zone and one third of the total to Germany and France alone). The household savings ratio in Spain is one of the highest among the OECD countries.
- On a cash basis, the central government’s deficit has fallen by 40% in the first 10-months of 2010, compared to the same period in 2009. Last Friday, the government proposed a series of structural reforms in addition to those already implemented throughout the summer, including public sector wage cuts and initial labour market reforms.
- As a whole, the two largest domestic banks are profitable (their ROEs are in excess of 20%), have raised equity recently, and have an internationally diversified balance sheet. Moreover, the banking sector has seen inflows into deposits, and their reliance on the ECB funding has diminished. The exposure vs. general government sector is lower than in the average of Germany, France and Italy.
- Finally, Spain is of much greater systemic relevance to the Euro-area than Greece, Ireland or Portugal. According to BIS data from March, the country’s largest external creditors are Germany, France and the Netherlands, and the risk is mostly with the private financial and non-financial sector (updated figures for June should be available in early December). Should tensions escalate (not our baseline) the prospect of a heavier response by policymakers, including a shift in ECB’s stance regarding the provision of term liquidity, is a distinct possibility
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Interesting thing is, unlike Ireland and Greece (and the now long forgotten but still struggling Iceland), Spain is actually a country that has a fairly healthy manufacturing sector.
But the impressions created are of a "tourist" nation. I think Spain's EU membership and thus it's being in the Euro's death-grip, unable to de-value uni-laterally, is an interesting thing. It's happening faster now, outliers to in-liers.
Looks more and more like a COL/FED inspired rout.
ORI
http://aadivaahan.wordpress.com
Also, adding in their horrible 3mo auction yesterday, Spain is in a dire situation indeed.
Yup. Underwater real estate owned by citizens of insolvent nations throughout Europe. Pretty picture!
Deadbeats untie!
Will it really stop at Spain? At what point will Italy or France have guaranteed so much crap debt that they too hit the wall?
That's exactly the main issue. Because of the interconnectedness of everyone/everything, once the peripherals are 'saved', its time for the core to suck it up and admit their problems. Unfortunately, that's when the real SHTF - i don't suppose any non-EU members will be willing to save them (minus the Fed's swap lines to the ECB and China's endless paper buying capabilities).
Italy???
they are in a worse position but TBTF so off the map for now...
I wouldn't be so sure. They're 1.5x Spain, GDP-wise. TBTF? Maybe, but then probably so would Spain be.
Like Spain - Italy 2-year spreads are also now at record highs.
This is the sort of English up with which I will not put! -- Winston Churchill
Spain Economy Watch
http://spaineconomy.blogspot.com/http://spaineconomy.blogspot.com/2008/11/spanish-crisis-in-nutshell.html
Spain's employment looks bad on paper, but it seems they actually count a lot more unemployed people as unemployed. That is something most nations cannot claim.
Other nations can have a ~70% employment rate, 8% unemployment and a gaping 22% hole :-).
Spain's employment rate is around 60% with unemployment at ~21% making the ratio of unemployed to inactive much lower.
dislexics untie
don't dys me bro.
Dick-lexics Unite!
Says Dimon and Blankfein...
"Back then the Stress Test farce brushed this biggest risk under the rug."
And the Fed is going to a Double-Secret stress test again...no disclosure of what's innit or what the results are.
"America...a Bank with a military"
When Spain fails, I wouldn't be surprised that it would get voted of the EU island to save the Euro.
Let's hope they do, because else WE'RE DOOMED!
Yesterday, as a form of protest, I've decided to NOT eat anymore calamares!
To Tyler:
The bank run fears are really getting to take form in Europe. Because of the call for a bank run on 7 december, people are now already starting to take out money from the banks because that event could blowtorch the banks.
PREVENTIVE RUN!!
It's Zeno's bank run.
But in any case, why should Spain be expelled from the Euro? Can't it default perfectly well inside the Euro?
Spain elected a socialist government in 2004 which immediately embarked on subsidized green techonology which has been a total bankrupt disaster with 20+ % unemployment. No end in sight.
Spain sure showed us, alright. I can't wait for our green Czar and the EPA to make us do that.
.
You really think that if you write off the last six years, Spain would not be in a dire situation?
Wonder who's going to be getting the biggest collateral calls on CDS exposure.
I am constantly amazed by Goldman Sachs ability to miss the real issues. If they are not very bright then you think by now the same rose tinted spectacled view of Greece, Ireland and soon to be Portugal might have taught them something. But it would appear not.
As to proper anaysis well I have just read this.
"With the problems elsewhere gathering one is forced to the conclusion that should Spain hit trouble then there is not enough money in the Euro zone;s rescue vehicles to successfully rescue her. This assumes that they will successfully rescue anyone, a concept subject to increasing doubt..... Added to this in an example of fiscal recklessness the Spanish government redid its fiscal calculations when yields on its debt fell and spent the expected gains (there was a particular announcement of 750 million Euros worth of spending). Now of course the gains have disappeared but the extra spending remains."
http://notayesmanseconomics.wordpress.com
Expect CNBC to espouse that "it just doesn't matter", because after all, it's only a global landscape when things are going well...yeah, tell that to the lynch mob.
Are they simply trying to perfect the EU to be not just a monetary union but a political/economic one as well by forcing all nations under their central control? Yeah, the CDS are the devils instruments...
Spain = UK's greatest nightmare
It's amazing that European stress test was a joke. Spain needs help and the EU knows it, but they are hopeing that they can pull a rabbit out of the hat and not go down this road. We are seeing the meltdown of the EU, and this brings up another thing also. Remember 2 months ago discussion about allowing business operations from the US who are overseas to re-invest their money back into the US but not being taxed. Maybe they know that they don't want their money in those EU banks when the hammer comes down.