While the media is abuzz with the notion that the Spanish bailout will save Spain, more key questions such as “where is the money going to come from?” are being ignored.
Indeed, at this point, it’s not clear if the Spanish bailout is coming via the EFSF or the ESM. If the funding comes via the EFSF then the entire exercise is pointless. The EFSF, if you’ll recall, is essentially a failed entity given that it couldn’t even raise €10 billion via bond auctions without having to step in to make sure the auctions didn’t fail.
Put another way, the EFSF doesn’t have the funds to prop up Spain. So if the funding for Spain’s bailout is to come from there, Spain’s not getting any anything.
However, if the funding comes from the other mega-bailout fund, the European Stability Mechanism (ESM), then ALL Spanish bondholders will become subordinate to the ESM.
Put another way, in the event of insolvency, the ESM’s claims will be senior to every one else’s.
Given that Germany’s finance minister Wolfgang Schaeuble wants the funding to come from the ESM (you’ll see why in a moment). It’s likely it will be the ESM who funds” the Spanish bailout as Germany is in fact the real backstop of the EU. So what Germany says goes.
Schaeuble Wants Spain Aid To Come From ESM, Handelsblatt Says
German Finance Minister Wolfgang Schaeuble wants aid for Spain’s banks to come from the future permanent backstop, the European Stability Mechanism, to avoid greater risks for the German budget, Handelsblatt said.
Spain would not be able to guarantee loans from the current backstop, the European Financial Stability Facility, if funds for its banks came from the EFSF, the newspaper said, citing European Union diplomats it didn’t name.
Germany’s share of guarantees to the EFSF would rise in such an event, the newspaper said. The ESM is financed by all 17 euro-region countries, including those that receive funds from it, the newspaper said.
If this occurs, a Spanish bailout via the ESM will ultimately damage the Spanish banking system as private bondholders and other investors will flee Spanish bank bonds since they know that they are not likely to get much, if anything, if a Spanish bank fails (which the markets now know they will).
Indeed, one has to wonder… just how does a €100 billion bailout solve Spain’s banking woes when its Prime Minister was suggesting the real damage is more to the tune of €500 billion in a text message to his Finance Minister???
Indeed, if Rajoy’s text is even remotely truthful, then we can assume that Spain’s real capitalization needs are multiples of the €100 billion bailout… something that the EU media is picking up on already. As one example, JP Morgan believes that when all is said and done Spanish banks could be looking at €350 BILLION in capital needs.
Bank bail-out won't end Spain's property nightmare
In a recent research note, economists at investment bank JP Morgan estimated that despite the €40bn (£32.4bn) or so that many in the market believe Spain’s banks need to be adequately recapitalised, the full requirement could be as much as €350bn once all is said and done.
It’s highly likely JP Morgan is accurate or even underestimating here. Remember, we’re talking about a banking system stuffed to the brim with loans made during the following housing bubble (Spain in blue, the US in gray).
According to the Economist in 2006, Spain built FIVE TIMES as many homes as the UK (FYI the Spanish population is 47 million… UK population is 62 million). Today, Spanish housing starts are down 90% from their peak and Spain is littered with unfinished projects.
However, instead of bringing their inventory to market, Spanish banks continue to offer loans of 95%-100% at low interest rates to attempt to sell these properties at inflated levels. Indeed, things are so desperate that literally every Spanish bank out there is launching English-speaking websites trying to lure buyers from around the globe into buying properties.
Those who buy will likely find themselves losing on the deal.
Bank bail-out won't end Spain's property nightmare
Recent data from the Knight Frank Global House Price index shows that Spanish residential properties fell by 7.3pc in the year to the end of March. Official Spanish data state that prices are down 20pc from the peak, but those figures are based on bank valuations, rather than actual sales.
In spite of the small but growing number of articles in the British media that ask whether now is the time to buy Spanish property, it is likely, if the case of Ireland is anything to go by, that values will fall by as much as 50pc from the peak before they begin to bottom out.
In this context, the following data points make it more than obvious that Spain will need much more than €100 billion to recapitalize its banks… and that Spanish banks will be increasingly facing insolvency due to their bond issuance schedule for the remainder of the year.
Consider the following…
- Spain’s banking system is roughly €3 trillion in size (3X Spain’s GDP).
- Spanish banks’ gross borrowing from the ECB was €316 billion in April.
- Spanish banks need to roll over 20% of their bonds (roughly) €600 billion this year.
Thus, by even a simple back of the envelope analysis it is clear that Spain will need a lot more than €100 billion to recapitalize its banks. How on earth Spanish banks can roll over €600 billion in bonds at a time when the global bond market has just learned that all private bondholders will be subordinate to the ESM is beyond me (read: it won’t happen).
Folks, the Spanish bailout isn’t going to work. If Spain’s Prime Minister admitted in private that needs are more like €500, then you can bet the €100 billion bailout, which isn’t even guaranteed at this point, will solve nothing.
So if you’re not taking steps for the potential that Spain could in fact default and take down the European banking system with it (NO ONE in the EU has €500 billion to spare), you need to take action now.
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