Spain has reversed itself and asked the Eurozone for “up to” €100 billion after not long ago insisting it could go it alone. The proximate cost was the increase in its sovereign debt yields in the wake of the announcement of a bailout of Bankia, which was cobbled together from dud cajas. Even though Spain’s bond auction last week got off better than expected, that was likely in part due to the expectation that the creditor states would indeed ride in to the rescue.
But will the latest, yet to be finalized remedy do anything more than buy a little time? The half life of Euro-interventions is shortening. George Soros has argued that the Europeans have at most three months, and the action they need to take must be decisive. Unfortunately the Germans are signaling movement, but the ideas they are touting, such as having debtor nations agree to cede more sovereignity and implementing pan-European banking supervision, aren’t like to be achieved quickly; indeed, they may require treaty approvals.
And there are reasons to wonder whether the Spanish bank rescue will accomplish its aim of bringing Spanish bond yields back to a more sustainable level. The first question is whether it is big enough. Even though the Spanish government is confident that €100 billion gives it an ample buffer, Spain’s unemployment level only recently gapped up to 25%. Without a fix for the underlying economy, it’s not hard for the powers that be to underestimate the stresses Spanish banks will face as the impact of job losses work their way through the economy.
Second is the bank rescue is being routed through Spain’s Fund for Orderly Bank Restructuring and repayment will be an obligation of the government, bringing its total debt outstanding from roughly €600 billion to as much as €700 billion. There is a good possibility that this change alone will lead ratings agencies to downgrade Spain from singe A to BBB.
Third is that the specific funding mechanism has yet to be decided. Even though the Spanish finance minister asserted the loan would be “on very favourable conditions, more favourable than in the market,” that remains to be seen. The funds will come from the EFSF and the ESM. The problem with that is that use of either one has adverse implications. Spain may have to get at least some funds from the EFSF, since the ESM is not operational for another month. But Finland insists that if Spain gets funds from the EFSF, it must provide collateral, and it is not likely that Spain has a ton of good collateral sitting around. To the extent the funds come from the ESM, those obligations will be senior to that of existing and new sovereign bond issuance. Needless to say, this change is not going to be a plus for Spain as far as its regular bond issuance is concerned.
Various commentators have argued that the Eurozone needs to backstop its banking system, say by issuing deposit guarantees. Instead, just as the Troika did with Ireland, the Eurocrats are intent on making a bust banking system the problem of its already-stressed government, even when the markets are certain to see around the circularity of that arrangement. We argued that the Irish had the upper hand and could have stared down the Troika (Irish bank failures would have blown back to certain German banks), but Irish were sold out by the head of their central bank. Spain was widely acknowledged as having considerable leverage in its negotiations with the officialdom; it is clearly too big to fail. So it is puzzling that it allowed itself to be put in the same position as the Irish. It seems the Spanish were so pleased not to be required to implement more draconian austerity measures that they settled for less than they could have.
As Marshall Auerback discussed by e-mail, this measure also fails to address the existential threat to the Eurozone:
There is a key flaw in the European monetary system that lies behind the current bank run, an all important difference between the Target 2 clearing system and that of the Federal Reserve. As Peter Garber explained in 1998, any possibility of a euro exit by one of the euro member countries creates a risk of a currency loss to parties involved in the euro area banking system. There is no parallel potential currency loss in the case of the US. No state is going to pick up and run and form its own new currency (Rick Perry’s mindless secessionist threats to the contrary in Texas). It is this potential for euro exit and subsequent currency loss that fuels the European bank run. It is this potential for currency loss that prevents the private interbank system from recycling flight deposit funds from recipient nation banks back to the banks in those countries where the deposit run originates. This is why the ECB has to step in and act as lender of last resort lynchpin in the system. There is no parallel need for such a Federal Reserve role in the U.S.
Peter Garber explained that, given the complete capital mobility in the EU and euro wide acceptance of a common currency, transferring deposits from a domestic commercial bank in one nation to a bank domiciled in another EU nation is costless. In a world of rational economic agents, any non-negligible perceived probability of euro exit and subsequent currency loss should result in a massive deposit run. The imbalances we see now reflect only the early stage of such rational behavior. The bank deposit run and therefore Germany’s unenforceable claims against the periphery countries could explode.
So, given these considerations, the ECB’s “unenforceable claims against the periphery” could be many trillions of euros by year end to which Germany would be massively exposed. Therefore, according to Soros’ logic, Germany would be all the more trapped into doing whatever is necessary to preserve the euro.
The endless stopgap measures have kept the Eurozone limping through its sovereign debt/banking crisis far longer than I thought possible. But the seeming success of bare minimum moves may well have conditioned the authorities to continue on that path. If so, it will prove to be their undoing.