ECB's Refusal To Play Ball Means Spain Has To Foot A €350 Billion Bailout Bill Alone

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Moving away from baseless (or is that faceless?) European bailout rumors, and moving into cold hard math territory, we hear from JPM's David Mackie that "If a Spanish EU/IMF bailout package covered the government’s gross funding needs through the end of 2014, and included €75bn for bank recapitalisation, then it would amount to around €350bn." This may be a problem since as pointed out on Tuesday, the Spanish Fund for Orderly Bank Restructuring (FROB) is down to... €5.3 billion.

From JPM: Spain starts climbing the steps of the liquidity hospital

The ECB’s rejection of the Spanish government’s plan to recapitalise Bankia – by injecting government bonds directly into the bank which would then be used as collateral in ECB financing operations – puts Spain on the steps of the region’s fiscally based liquidity hospital (EFSF/ESM). It looks increasingly likely that it will be knocking on the door soon asking to be admitted.
 
Crisis management is all about burden sharing: who bears the cost of prior mistakes. Spain looks to have gotten to the point where it cannot bear the burden alone. The Spanish government recognises the need for burden sharing, but it does not want the kind of burden sharing that was made available to Greece, Ireland and Portugal. The Spanish government wants the ECB to directly purchase its sovereign debt and for the EFSF/ESM to directly recapitalise its banks.
 
As far as a genuine shift in credit risk is concerned, there is no real difference between ECB sovereign bond purchases and EFSF/ESM loans to the sovereign. From the Spanish government’s point of view the former is more attractive because there is no loss of sovereignty: SMP bond purchases do not come with conditionality. But, who recapitalises the banks is a huge issue. Given the likelihood that there are still a lot of losses that have not yet been recognised, a capital injection into the Spanish banks directly from the EFSF/ESM would be a boon for Spanish taxpayers. Future losses would be absorbed by the area wide taxpayer.
 
But, the sort of burden sharing that the Spanish government wants is not on offer. It could be argued that the government is delaying asking for EFSF/ESM help in the hope that the rest of the region will change its stance. Certainly a Greek exit would likely catalyse the kinds of changes that the Spanish government wants. But, it is not clear that Greece will exit anytime soon. Spain probably doesn’t have the luxury of waiting.
 
Before Spain asks for admission into the liquidity hospital we may see the SMP reactivated. But, given that the Spanish situation looks increasingly like a solvency crisis – the government is not solvent enough to recapitalise insolvent banks – the ECB is unlikely to view the SMP as an appropriate long term response to this problem. More likely, SMP purchases would simply be used to limit market turbulence while a traditional bailout package was negotiated.
 
If a Spanish EU/IMF bailout package covered the government’s gross funding needs through the end of 2014, and included €75bn for bank recapitalisation, then it would amount to around €350bn. A traditional package would keep the burden of adjustment squarely on the shoulders of the Spanish taxpayer. Spain could be accommodated in the liquidity hospital as currently designed, but a Spanish admission would force the region to think hard about both the size of the fiscally based liquidity hospital and its funding. It would push the region closer to a hybrid liquidity hospital, where governments provide capital and the ECB provides funding.