Spain And The Citi: Here Is What Happens Next In The Country With All The Pain

Tyler Durden's picture

While this morning saw a rumor of junior bank bondholder haircuts (and burden-sharing) rapidly denied by Spain's de Guindos, it appears the country's smarter individuals are realizing that perhaps a 'bail-in' (a la Citigroup in 2009) is the better way to go than an unending 'bailout' when it comes to the problem banking system. As the WSJ noted last week "consider the grim fact that even €100 billion may not be enough to put Spain's banks back on their feet, as they could easily face losses of perhaps three times that amount" confirmed in yesterday's Oliver Wyman reality check.

The bigger issue is not the insufficiency of the loan but the fact that such a relatively small loan was impossible for the sovereign to raise itself as no private investors believe their solvency - implying Spain has reached its debt saturation point. Neither government nor taxpayers can afford to take on more debt (which is what the bailout is).

The solution, a precedent set by the good ol' USofA with the Citi preferreds, is to cram-up bond-holders. A compulsory debt-for-equity swap for the subordinated and senior unsecured liabilities, "whereby investors bear the vast majority of the cost of their own mistakes, without liquidating the banks and without pushing the Spanish economy into bankruptcy" may initially cause some turmoil in the interbank lending markets (which would need to be supported by the ECB in the interim as it is already) may be extremely painful for shareholders (who will see massive dilution) and bondholders (arguably rightfully so) but would offer hope for improving market belief in solvency.

A Senior-Subordinated spread decompression trade in credit would seem to make sense - given the considerable hit taken to the subordinated class (whether it triggered CDS or not) and sets up to be the macro trade for the coming months.



especially given the following 'math' from the WSJ's story:

Converting into equity 100% of the €88 billion of subordinated liabilities, and 40% of the €160 billion of senior unsecured debt, would generate more than €150 billion of loss-absorbing equity for the Spanish banking system. Together with the estimated €25 billion in expected operating profits for 2012, before loss provisions, that would yield about €175 billion in new bank equity, without increasing the debt burden of the Spanish taxpayer or requiring a loan from Brussels.


As The Economist wrote back in 2010:

Many investors would no doubt complain about the rough justice of a regulator-imposed reorganisation. To preserve value, officials would have to move very, very quickly, leaving little time to fine-tune various claims or observe normal procedures. The new structure would be based on bankruptcy reorganisation principles, allocating value in accordance with investors’ seniority and ensuring that each class of investors would be better off than in liquidation. The process would not be pretty but overall, investors should be relieved by the result.


Why can’t the bankruptcy code do this today? To an insolvency professional, this restructuring looks somewhat like a “prepackaged” bankruptcy, in which creditors agree to a new, less leveraged capital structure negotiated over a period of months. But a lengthy, voluntary process is impractical in the panic surrounding the failure of a very large, complex financial institution.


As Juan Ramon Rallo notes in the WSJ article last week:

Instead of a bailout, the Spanish state should force a "bail-in," in which much of the banks' debt is converted to equity. This would reduce the banks' leverage and increase the capital available to absorb the coming losses... and after some time, short-term credit would flow again inside a country with much more robust and solvent financial institutions.


Perhaps the 'bail-in' is best summarised by a comment from the WSJ story:

Essentially, this is a proposal for financial restructuring (aka bankruptcy) without bothering to go to the courts. Its cleaner, less disruptive, and less expensive than where we are headed otherwise. The money has already been lost. Someone has to book it.


Seriously, when should investors in the debt of financial entities take a loss if not now? Never?

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Mugatu's picture

I would like to do the same thing to my mortgage lender right now - make them convert their loan  into house equity.

I am sure nobody will mind this.

Poetic injustice's picture

Instead I would suggest to offer them negative interest rate... or ELSE!

battle axe's picture

Bondholders are senior to everyone. Oh wait this is the "New and Improved Financial Markets", or I like to call it "Thunderdome" two man enter, one man leave, and rules are? There are no rules. 

jal's picture


You cannot turn on the TV or the radio without hearing about 


The implication being that the borrowers are in trouble.

The borrowers are not in trouble they cannot pay back the loans and the collateral for those loans are non existent.

The truth is that the lenders are in trouble for making loans that they should have refused to do if they had done their due diligence.


The real headlines should be



Lenders need the bailout NOT the borrowers.


Buck Johnson's picture

"The bigger issue is not the insufficiency of the loan but the fact that such a relatively small loan was impossible for the sovereign to raise itself ".  I've made this comment on more than one occasion.  If the govt. of Spain with a GDP of 1.4 trillion can't come up with this little amount of money then they are insolvent pure and simple and they will need alot more money in the near future.  Also sooner or later investors are going to get hip to this situation of subording the debt holders and such and they may rush and dump their bonds in order to get a better deal.  Because that equity thing will never make them whole.

ebworthen's picture

Subordinating bond holder rights - brought to you by the nation supposedly the nexus of "free market capitalism".

U.S.S.A. innovates again!  Did the subordination (theft) idea come from California?

And why isn't JON CORZINE in a prison cell?


Mugatu's picture

Hey, this is the greatest idea since swiss cheese!  You can use it for everything.  We can cure the US deficit in one day - every bondholder now owns 1 share of the USA.  No interest payments and we have just created the largest peice of crap IPO since Farcebook.

Legolas's picture

Right now, it would be the only IPO since Farcebook.  Let's take a couple of months to hype it up too.  It'll be just like Christmas.

buzzsaw99's picture

The shareholders are supposed to be completely wiped out before the bondholders lose a penny. Rewrite the rules owebammy. WTG!

kito's picture

let europe PRINT!! it will make everybody happy....the "elected" officials, govt employees, the pensioners, socialized banks like citifed, stock holders, pm holders, all will be happy!! PRINT PRINT PRINT!!! 

insanelysane's picture

No one, and I mean NO ONE, in power is ready to face reality but I do love the following quote: The money has already been lost. Someone has to book it.

RoadKill's picture

Makes too much sense and is far too "free market" of a solution. I cant understand why you would ever need a tax payer bailoit of a bank when you can force convert all the debt to equity.

holdbuysell's picture

CDS implications? ISDA?

Zeilschip's picture

Exactly. Would this 'bail-in' be a restructuring credit event thereby triggering CDS on both sub and senior debt?

timbo_em's picture

Spain doesn't want to wipe out or convert junior bondholders because a lot of Spanish banks sold large quantities of junior debt disguised as saving products to customers. And when I say customers I mean voters. It would be political suicide for Rajoy et al. I'm not sure, what the donors think about that approach, though.

Sudden Debt's picture

Never the less, economies only grow when they take more debt. 3 to 4% in normal situations. So 0% is below zero growth untill the ends of time.
No more room to take on more debt = finished!

Keynes will agree with that one!

ddtuttle's picture

Of course that growth is NOMINAL, not REAL.  Subtract inflation and you've got a recessionl.  

Von Mises will agree with that one!

ddtuttle's picture

I guess the idea is that Spainsh banks will appear solvent after this, and immediately go to the market to borrow enough money to become insolvent again ... cool.  

Of course, this won't trigger any CDS, because this OBVIOUSLY isn't a default.

And, preferreds typically have an interest payment, and the new borrowed money will be at what rate? 7%? Let's pile as much debt on as humanly imaginable before BK'ing this MF.

We have passed through the Twilight Zone, through all of Salvador Dali's paintings, through The most psychotic of Timothy Leary's 30,000 acid trips into .... what!?


Snakeeyes's picture

At least Spain's 10 year sov yield is below 7% thanks to the ECB. But that is short run and an "Extend and Pretend" strategy. NOT sustainable!!!!!!!!!!!!!

El Oregonian's picture

I'm getting a funny feeling that we will soon see an inquisition on the horizon...



decus ad mortum

bigwavedave's picture

Prediction: Germany 4 Greece 2 (2-2 half time)

If we are looking into the history of this fixture, we simply have to mention the famous final second leg in Munich's Olympic Stadium between the German philosophers XI and their Greek counterparts (courtesy of Monty Python).

Germany started favourites in that game as well, but were beaten by a controversial last-minute headed goal from Socrates. The goal was hotly disputed by the Germans, with Hegel arguing that the reality is merely an a priori adjunct of non-naturalistic ethics, Kant via the categorical imperative is holding that ontologically it exists only in the imagination, and Marx claimed it was offside.

green888's picture

the gamechanger is that Germany asked to "lend" a player to Greece

slewie the pi-rat's picture

i'm in!

justa sec!  lemme get carl icahn in too, ok?

and hurry, BiCheZ, or the elites will get in first!  L0L!!!

all seriousness aside, this doesn't seem bad from slewienomics, but let us keep in mind this is the debt of the corporate commercial and whatever banksters' banks' debt/bonds and other cooties

this bank debt will be taken off the books and swapped for stock, diluting the shit outa the common ownership but leaving the other 1760 types of equity with the new money for being alive again and back in bidness

now!  about those loan and investment portfoilios and yer still-negaive net worth...?  ohMGoodness!  did i forget the "deposits"?  _..<^/|\>,,_TRANSFUSION

John_Coltrane's picture

This is what should have occurred to the US banks in 2008.  Bail-in, not bail-out.  Foolish equity and bondholders in failed companies should suffer the losses, not savers and taxpayers.  In the future, people would be a lot more careful to whom they loan funds and the underlying capital/assets supporting those loans.  Realize that the entire housing bubble and finacial meltdown could have been prevented by requiring 20% downpayment to purchase a house-thus eliminating deadbeats with no savings from the housing market.  This real capital requirement insures the borrower has a demonstrated ability to manage money (they saved 20% after all from real work and earnings) and real "skin in the game".

Cheap money, low interest rates always results in malinvestment.  Just as spending other people's money is a huge moral hazard which always ends badly.

machineh's picture

'Cheap money, low interest rates always results in malinvestment.'

My name is Alan Greenspan, and I resemble ... errr, resent ... your callous insinuations.

shovelhead's picture

Bu-but what about the poor unemployed crack-heads...

Don't they deserve to be homeowners too? Ya know, fairness and all that social justice stuff they teach in school these days.

bombimbom's picture

European officials proposed Wednesday a new system of financial regulations that aims to keep bank failures from costing taxpayers billions and bankrupting governments.

The Alternative Investment Fund Managers Directive (AIFMD) seeks a common EU approach to bringing hedge funds, private equity and other types of funds without a UCITS passport within the scope of regulatory supervision, and to bringing transparency and stability to the way these funds operate.


MiniCooper's picture

A 'bail in' is absolutely the right way to go and in particular making subordinated debt holders convert to equity has been the blindingly obvious solution since the start of the financial crisis as an orderly way of bringing more equity capital into the banking.

Why have politicians so studiously avoided pushing it as a solution instead of using tax payers money?

Vested interests stopped it happening that is why. 



machineh's picture

'Why have politicians so studiously avoided pushing [bailouts] as a solution instead of using taxpayers money?'

Because when bondholders and politicians are the only two parties at the table, why shouldn't they rip off a third party [taxpayers] who aren't even there?

Especially when said taxpayers have been brainwashed to believe there's only two choices, Democrats and Republicans, both of whom will gleefully fleece them for all they've got.

Shearing sheeple -- who said there ain't no such thing as a free lunch?

MiniCooper's picture

In fact, if G20 leaders really wante dto solve thsi problem. Shut teh global financial markets and banking system for a week and do the forced debt-equity conversion in strict order of seniority.

It would be all over with in a week, some financial blood spilled but it would be orderly and the chaos of a disorderly global banking crisis truely averted. 


This is the end's picture

This is the idea that ZH was founded on. Start writing down the debts! They are not going to be paid. Don't try to cover the debts up with printed money. It doesn't work (see Japan, Greece, Portugal, US etc.) and it just kicks the can making the inevitable problem much worse. The point almost everyone here on ZH has in that policy makers need to deal with reality! Stop trying to manipulate markets, economies and debts to pretned like they don't exist. Deal with them one by one and you can get a handle on them. Make the investors and governments take the losses.

CreativeDestructor's picture

who me? Investor?! Bankster?! take a loss on my brilliant sure investments!? NEVER!!!