Satyajit Das: The Spanish “Bailout”, Whoops – “Assistance”!

By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011). Jointly posted with Roubini Global Economics.

On 11 April 2011, then Spanish Finance Minister Elena Salgado stated: “I do not see any risk of contagion. We are totally out of this.” A little over a year later, Ms Salgado and her party are no longer in power and Spain is well and truly in it.

After weeks of prevarication, Spain will now apply for a bailout for its banking system. Sorry it’s not a “bailout”. As the Spanish Finance Minister clarified: “What is being requested is financial assistance. It has nothing to do with a rescue”.

It is quite a turnaround. The new Finance Minister Luis de Guindos stated on 30 March 2012: “We are convinced that Spain will no longer be a problem, especially for the Spanish, but also for the European Union”. The Spanish Prime Minister Marino Rajoy attempts to maintain confidence a few days later on 12 April 2012 were confusing: “To talk about a bailout for Spain at the moment makes no sense. Spain is not going to be rescued. It’s not possible to rescue Spain. There’s no intention to, it’s not necessary and therefore it’s not going to be rescued.”

But the bailout may not work.

The amount – €100 billion or more depending on the independent assessment of the needs of Spanish banks- may not be enough. On the surface, the amount appears around three times the €37 billion the International Monetary Fund (“IMF”) says is needed. The capital requirements of Spanish banks may turn out to much higher – as much as €200-300 billion.

The IMF assumes only the smaller Spanish savings banks (the Cajas) will need help. In reality, the larger Spanish banks may also require capital.

Spain’s banks have over €300 billion in exposure to the real-estate sector, mostly through loans to developers. Around €180 billion of this exposure is considered “problematic” by Spain’s central bank.

Estimates suggest that there are about 700,000 vacant newly built homes, but including repossessed properties the total could be as high as one million or even higher. At current sales levels, it will take many years to clear the backlog, which will be compounded by more properties being completed and coming onto the market. Housing prices have fallen by 15-20% but are forecast to fall eventually by as much as 50-60%. A severe recession and unemployment of 25% means that losses on Spain’s over €600 billion of home mortgages loans are likely to also rise.

The proposed amount also does not include any provision for write downs on holding of sovereign debt. Local banks are estimated to hold over 60% of outstanding Spanish government bonds.

The bailout will be provided with no conditions, which creates its own problems. The lack of conditions may lead to Greece, Ireland and Portugal seeking relaxation of the terms of their assistance packages. The lack of conditions also prevented the IMF from contributing.

In an opinion piece in the Financial Times, Jin Liqun, Chairman of the supervisory board at the China Investment Corporation, pointedly noted the contrast between the treatment of European and Asian countries. “Viewed from China, the management of the eurozone debt crisis offers a stark contrast to the handling of the 1997-98 east Asian crisis. In that episode, Thailand, South Korea and Indonesia were all forced to implement tough austerity programmes imposed by the International Monetary Fund…. Unlike many of today’s Europeans, the people of east Asia did not have the luxury of large relief funds from outside their countries. The people had to tolerate hardship…In a poignant case, the Korean people contributed gold and household foreign exchanges to the government to help ease fiscal pressure.” Future international support, either bilateral or through the IMF, may be difficult.

The funds will come from either the European Financial Stability Fund (“EFSF”) or the still to be approved European Stability Mechanism (“ESM”). Since 2010, the Euro-Zone has committed Euro 386 billion to the bailout packages for Greece, Ireland and Portugal. In theory, the EFSF and ESM can raise a further €500 billion, beyond the commitment to Greece, Ireland, and Portugal, allowing them to contribute the €100 billion for the recapitalisation of the Spanish banking system. The EFSF/ESM also assumes that it “can leverage resources”. The reality may be different.

For a start, Finland has indicated that it may seek collateral for its commitment, an extension of its position on Greece which the European Union ill advisedly agreed to.

As Spain could not presumably act as a guarantor of the EFSF once it asks for financing, Germany’s liability will increase further from 29% to 33%. France’s share also increases from 22% to 25%. The liability of Italy, which is in poor shape to assume any additional external financial burden, rises from 19% to 22%.

The EFSF’s AA+ credit rating may now be reduced. Irrespective of the rating, the EFSF and ESM will have to issue debt to finance the bailout. Support for any fund raising by these instrumentalities is uncertain.

Commercial lenders have been reducing European exposure. Emerging market members with investible funds lack enthusiasm for further European involvement. Lou Jiwei, the chairman of China Investment Corporation, the country’s sovereign wealth fund, has ruled out further purchases of European debt: “The risk is too big, and the return too low”.

The bailout also does not address fundamental issues.

The funds will be lent to the Spanish government, probably its bank recapitalisation agency FROB, rather than supplied directly to the banks because of legal constraints. This will add 11% of Gross Domestic Product (“GDP”) to Spain’s debt level. The transaction will do nothing to reduce the country’s overall debt level –over 360% of GDP before this transaction.

Spain’s access to capital markets or its cost of debt is not addressed. The last auction of Spanish government bonds saw yield around 6.50% per annum with the bulk of bonds being purchased by local banks. Spain and its banks also face pressure on their own ratings, which are now perilously close to becoming non-investment grade.

The bailout may actually adversely affect the ability of Spain and its banks to funds. Commercial lenders are now subordinated to official lenders. Based on the precedent of Greece, this increases the risk significantly, discouraging investment.

The European Union has stated that they believe that these measures will help the supply of credit to the real economy and assist a return to growth. This optimism is unlikely to be realised.

Restoring the bank’s solvency will not result in an increase in credit. The capital will allow existing bank debts to be written off. Spanish banks have limited access to funding. They are heavily reliant on the European Central Bank for money; a position which the assistance does not address.

But even if the flow of credit improves, it would merely allow half finished building in the middle of nowhere and with no obvious buyers to be completed, compounding the overhang of unsold property. Given that Spain’s problems were caused by a debt fuelled property boom, more of the same does not seem to be a sound solution.

Slowing economic European and economy growth is also likely to limit any recovery and improvement in Spanish employment and investment.

Prime Minister Mariano Rajoy made the quixotic claim that the assistance was a victory for Spain. Opposition Socialist Party leader Alfredo Perez Rubalcaba retorted that: “The government is trying to make us believe we have won the lottery”.

Spain will need to win the lottery – probably its own El Gordo (the big one) the world’s biggest lottery – if it is to avoid a full scale bailout, which may be beyond the capacity of Europe, economically and politically, to undertake.

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  1. Gerard Pierce

    The real question is why these people are still in government. Is there a shortage of rope – or a shortage of lamp posts?

    1. binky bear

      sort of insensitive after the whole Franco thing. Been there, done that, suffered under a Fascist regime for decades.

      1. Gerard Pierce

        I would have suggested simply firing them, but they would probably emigrate and wind up working for the US Fed.

        1. ambrit

          Mr. Pierce;
          The way this, ahem, ‘assistance’ looks to be financed, they soon will be working for the U.S. Fed.

    2. carol

      Gerard: “The real question is why these people are still in government. ”

      I found the answer to that important question in last Friday’s Guardian newspaper:

      “As European taxpayers prepare to rescue Spain’s ailing banks, anti-corruption prosecutors, academics and regional parliaments are uncovering a tale of greed, cronyism and political meddling that has brought many of the country’s leading savings institutions to their knees.”

      “The bill that Europe’s rescue funds must pay has been increased by the multi–million euro payoffs taken by some senior executives shortly before their banks collapsed”

      “The use of cajas as the banks of regional governments is part of the origin of the problem. [The politicians] used these banks to finance airports with no flights and theme parks that failed.”

      And more:

  2. psychohistorian

    Nice summary of the situation. I wonder what the 25% unemployed think of this debt responsibility in their future….can they immigrate? Where to? Germany?

    What are the youth of the EU to make of all of this? Its not just a career choice but a country within which that career choice has a future. Or as Tom Waits’s puts it, “…two dead ends, but you still got to chose.”

    Lets hope the youth of the world chose another path that puts the 99% in charge and the 1% out of control of money, finance and governments everywhere.

  3. Ignacio

    S. Das wrote:

    “In an opinion piece in the Financial Times, Jin Liqun, Chairman of the supervisory board at the China Investment Corporation, pointedly noted the contrast between the treatment of European and Asian countries. “Viewed from China, the management of the eurozone debt crisis offers a stark contrast to the handling of the 1997-98 east Asian crisis. In that episode, Thailand, South Korea and Indonesia were all forced to implement tough austerity programmes imposed by the International Monetary Fund…. Unlike many of today’s Europeans,…”

    So, Mr. Liqun seems to ignore that the rescue of european countries goes with an austerity program that has sunken Greece into depression followed by Portugal and Spain (and also Ireland if we consider GNP instead of GDP measures). He also seems to ignore that he rescues are funded basically within the eurozone.

    1. Ms G

      Excellent catch. That’s what we’d call a blind spot the size of space and the milky way. Good to know these high level finance types are really up on basic facts — very reassuring.

    2. Yata

      I think the funding in question is the direct involvement of the IMF, and not the EFSF, ESM, or ECB.
      Not that it actually matters. Theres only so many different ways you can style debt until TPTB exhaust their littany of bullshit beliefs and excuses for what they know they will never get a handle on.

      There’s three types of people in this world; those that are good at math, and those that aren’t.

  4. JD

    On June 1, Nomura Securities estimated the bad debt of the Spanish banking system was €300 billion; the next day, the United Bank of Switzerland said it was €375 billion; on Monday, June 4, the Financial Times reported €475 billion. And this, is undoubtedly an underestimate as well.
    The total of Spain’s debts which will have to be covered in the immediate period ahead are in the ballpark of €1 trillion: €600-700 billion for the private banks, about €50 billion for the country’s regions, and some €200-250 billion for the national government. This would be about a quarter of Spain’s estimated total public and private debt of €4 trillion, as of the end of 2011.
    And none of this takes into account the uncharted amounts of derivatives that are piled on top of each of these categories. One analysis done last week, by former IMF economist Simon Johnson, estimated the total euro-denominated derivatives debt outstanding at €185 trillion.
    The rough one-trillion-dollar ballpark figure estimate is over by a couple of billion, even tens of billions, or even a couple hundred billion—although more than likely, the real total is probably even higher than a trillion. The point is the same: the debt piled on Spain by the banking system cannot be paid.

  5. Bakasone

    Oh yeah, the Koreans. Didn’t they even go and donate blood to pay down the debt accumulated by the chaebol?

  6. Jim Haygood

    ‘Irrespective of the rating, the EFSF and ESM will have to issue debt to finance the bailout. Support for any fund raising by these instrumentalities is uncertain.’

    Do tell! To date, EFSF has raised 8 billion euros each for Ireland and Portugal.

    Raising 100 billion euros for Spain is a much larger, if not impossible, task. To paraphrase Samuel Johnson,

    “Sir, Europe’s rescue funding is like a dog’s walking on his hind legs. It is not done well; but you are surprised to find it done at all.”

    1. JD

      All this money is going right to the banks. If we don’t pay the banks, they will go broke. In the S&L case the government bankrupted them or took them over and wrote off the debt and jailed the bankers. FDR closed down the banks within 6 days of taking office and then engineered Glass-Steagall to make sure that the people don’t have to pay off bad bets of speculator trading houses. Either we bankrupt the banks or we eat our children.

  7. Hugh

    It’s interesting how short the half-life of these can kicking, I mean non-rescue rescue packages, has become. Asian markets were up, but the animal spirits didn’t even make it to Europe. With the exception of a few safe havens, like Germany and Switzerland which were up slightly, the European markets were down although not breathtakingly so. The same kind of negative reading is currently what we see in New York as well. I thought that this BS would spark a rally for at least a couple of days for a financial community that lives on denial, but apparently not so or not yet this time.

    I think Das does a good job of pointing out the problematic sources of this bailout, as in will this even really come off. In this regard, it looks like a repeat of previous European efforts where a solution was announced that turned out to be 99% air.

    It is also important to consider where this money, if it does materialize, is going. I rather doubt that the Spanish banks’ bad loans were funded solely by depositors. I would think a lot of it was funded by money coming from Northern banks, principally French and German. So again for me, what this really looks like is a bailout by Northern countries of their banking sectors with the Spanish on the hook ultimately for the principal plus interest involved.

    1. Marc

      Hugh, I think you hit the nail on the head. Banks in France, Germany and the US have exposure to Spain. The “loan” aka bailout, makes those foreign private investors “whole” and transfers the “losses” to the Spanish taxpayers in the form of higher public debt. To finance such debt, the “market” will require public sector austerity and tax increases in Spain, both of which will constrain future growth.

    2. Rcoutme

      In his book, S. Das said that the problem with having the local banks be backed by their governments and the governments borrowing from their local banks would come full circle. Now it is happening. Pretty good predictor as far as I’m concerned.

  8. Conscience of a conservative

    The concept of debt has become a joke. Bad debts are not restructured and more and more of it gets transferred to the tax payer. The amount of mis-allocated spending gets worse and worse and the pundits just call for mroe debt.

    1. Wat Tyler

      This merger of state and finance is a feature of State Capitalism which seems to be the future of the West as it is the current Chinese model. Perhaps the Tea Party and Occupy movements need to merge as they are objecting to different sides of the same coin.

      Anyhow, Spain is 1.25 million Euros better off today thanxs to Mr Nadal. Congrats.


  9. Eric L. Prentis

    Malinvestment, malinvestment and more malinvestment—the economic consequences of additional bank bailout insanity, throwing good money after bad, is devastating, long-term.

    The 1% banksters continue to win, screwing the 99%. One-hundred thousand psychopathic banksters should be in prison for five years and barred from the financial industry for another ten years. This is the only way to get the fraudsters out of the political process, so we can implement real economic change.

  10. Min

    “The bailout will be provided with no conditions, which creates its own problems. . . . The lack of conditions also prevented the IMF from contributing.”

    That’s a strange way of putting the decision of the IMF. ¡Pobrecitos!

    “Irrespective of the rating, the EFSF and ESM will have to issue debt to finance the bailout.”

    Let me get this straight. The funds that provide bailouts do not have enough money to provide bailouts. Helluva way to run a railroad.

  11. John Yard

    Deal with this like the US dealt with the Savings&Loans :
    close the bank, fire the management, stockholders get nothing , bondholders 15 cents to the dollar, write down the debt, prosecute and jail the thieves , rebuild to a new bank.

    It will be hell on the stockholders and bondholders , but the nation will quickly recover. The elites don’t want to take the hit.

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  13. Ms G

    So let us get this straight. In our supposedly global free market economy, banks and governments and hedge funds and “bondholders” (whoever they are) get to make bets on Red and then get to be made whole on the backs of working people and taxpayers if the little ball lands on Black.

    Ok. Fair is fair though. Time to apply this Make-Whole System in a manner consistent with equal protection and due process. All of us should be getting dollar for dollar (plus interest) checks from Uncle Sam equaling losses in any type of retirement or savings or investment account that lost any money since 2007. And that is just for starters.

    I have not read or heard one cogent argument for why this current state of affairs (wage earners and the “little people” exist to bailout the incompetence of “market actors” chasing the next “super clever move”) is defensible.

    Let the Make-Whole Payments (Restitution) to US begin. Those brilliant financiers, bankers, investors, consultants, bondholders, whoever they are can apply the clever little minds to securitising, derivatising, swapping and defaulting, magnifying, shrinking, “de-leveraging”, or whatever it is that floats their boat.

    1. Yata

      Its because of your pensions and investments that this is happening. With $30 Trillion under management, and the majority of pensions underfunded, think what TPTB have to do to create a return for you or face the pitchforks and nooses when you finally figure out what you’ve been sold.
      The next time you stop to calculate your plan contribution costs, add the bailouts and lost savings rate.

        1. Yata


          Its fairly simple. You handed over your earnings to these financial types, not me.
          For the rest of the story you only have to sit back and watch.

  14. rotter

    Someone should make the movie. The Eurozone is a camp horror movie to be sure, lots of shambling zombies. Maybe call it, “They Saved Alexander Hamiltons Brain” ?

  15. tiebie66

    It seems to me that Das makes an implicit case for austerity:
    “But even if the flow of credit improves, it would merely allow half finished building in the middle of nowhere and with no obvious buyers to be completed…”
    Austerity has two major benefits: (i) if sufficiently troublesome, it spurs a (hopefully beneficial) change in behavior (vide Tsipras in Greece) and (ii) it cleanses malinvestments that otherwise linger in a far more costly manner.

    On a somewhat different note, I find it confusing that Spanish banks have limited access to funding and are heavily reliant on the ECB for money. Are Spanish banks, unlike their US brethren, reserve-, but not rate-, constrained in lending? And where do the British, French, and German banks fit into the picture? I suppose the confusing part is the demarcation between deposits and non deposit-based loans. Spanish banks have over E300 billion exposure to mortgages of which E180 billion is in trouble.
    But is this the problem or is the withdrawal of deposits (which must amount to far less) a problem or is credit creation a problem? If existing debt is written off with external funds, then credit creation can resume, no?

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