Questioning Footing Spain’s Bailout

The 100 billion euro (US$126.3 billion) bailout of Spain’s banking sector wasn’t received favorably by some investors, while others suggested that it was a step in the right direction.

“Pardon my skepticism, but I see numerous problems. In the first place, €100 billion will not be enough. While the current estimates are closer to €40 billion (if you ask the Spaniards), JP Morgan estimates it will be more like €350 billion. Others estimate more or less, but €100 billion is decidedly optimistic,” suggests an article on The Market Oracle Ltd. website.

At issue is the fact that Spain will have to keep borrowing. For one, the Spanish government neglected to include approximately 35 percent of its losses in its projections.

“Even the Spanish authorities are acknowledging that there is another 35% downside for the housing market, which is the main source of the losses. It appears that has NOT been included,” the Market Oracle article said.

Where is the Bailout Money?

One more major issue is that “it is not clear exactly how this bailout (let’s call a spade a spade) is going to come about. … I am sure there is a coherent plan here somewhere, but I can’t find it,” the Market Oracle article said.

Analysts in a number of articles suggest that the European Financial Stability Facility (EFSF), the European Stability Mechanism (ESM), the International Monetary Fund (IMF), or the European Central Bank (ECB) might be involved in the funding.

But “the IMF isn’t involved. Nor is the ECB,” a recent Phoenix Capital Research LLC article suggests.

The EFSF doesn’t appear to be a possible funding source either, according to Phoenix Capital Research. The EFSF’s investors apparently insist that bonds issued by the EFSF be insured, or they won’t risk making the investment. And the ESM, as discussed below, is still on the drawing board and won’t be formed for a while.

Then consider that “Spain and Italy make up 30% of the ESM’s supposed ‘funding.’ … Nearly one third of the mega-bailout fund’s capital will come from countries that are bankrupt themselves and are either already requesting bailouts (Spain) or soon will be (Italy),” according to Phoenix Capital Research.

The EFSF, formed in May 2010, was established to provide support to weak eurozone countries. The EFSF issues bonds, with investors including mostly institutions, such as banks, pension funds, central banks, sovereign wealth funds, and insurance companies. The EFSF is authorized to lend up to 440 billion euros (US$555.9 billon) and provide guarantees for up to 780 billion euros (US$985.3 billion).

The ESM, envisioned to become a permanent crisis management mechanism, will replace the eurozone’s European Financial Stability Facility and the European Financial Stabilization Mechanism, with an estimated launch date of July 2013.

Backlash in the Making

“What precedent is this setting? (Ireland is already clamoring for a rewrite to its bailout rules),” a recent Phoenix Capital Research article asks.

Should the EFSF or ESM be used, there could be a backlash from other needy nations, such as Greece, Portugal, and Ireland, who might ask for renegotiation of deals they had agreed to. In addition, the Dutch and Fins advised that they do not want existing funds to be given to Spain.

Apparently, the Spanish prime minister was adept in getting the German negotiators to cave in and agree to the terms of the bailout.

Just before the bailout negotiations began, Mariano Rajoy, prime minister of Spain, sent a message to Luis de Guindos, Spain’s economic minister, telling him that Spain wasn’t some backward country, but a major player in the eurozone.

An article on The Market Oracle website, quoting Joe Weisenthal of the Business Insider, suggested an interpretation of the Spanish government’s pre-negotiation stance: “Bottom line: hold out for something good. We are powerful, and if they don’t give in, the whole thing will go down. It will cost Europe 500 billion if Spain goes bust, and then another 700 billion if Italy goes bust.”

Risky Situation

“The Spanish ‘bailout’ could prove to do more harm than good,” the Market Oracle article warned, quoting Louis Gave, CEO of GaveKal.

Investors have been comparing the Spanish bailout to the Greek bailout. The situation that led to the Spanish bailout has similarities to components in the Greek bailout, such as a possible run on banks, moving money to other countries, and having government debt transposed into subordinate debt.

Subordinate debt means that the government has to play second fiddle to the European Union and the loan is provided not so much to shore up the banks, but to support the sitting government. When a government loses its unsubordinated debt position and becomes junior to other lenders, investors will no longer be interested in such securities, because the risk is too great.

“Most investors who buy government debt do so on the premise that the paper is the most ‘risk-free’. These are not equity investors, carefully weighing the risk-reward of a current asset,” Gave suggested.

Bailout—The Best Thing That Could Have Happened

An article on the Business Insider argues that Spain’s bank bailout is opportune and a great strategy. Peter Tchir, manager at TF Market Advisors, suggested in the article that investors are getting cold feet too easily and haven’t taken all probabilities into consideration.

Most of all, the fund is not lending to the Spanish government, but to the Spanish Fondo de Reestructuración Ordenada Bancaria (FROB)—the Fund for Orderly Bank Restructuring. The FROB was created in 2009 to manage restructuring processes of financial institutions. The FROB and the Spanish government are separate entities, although both are part of the Spanish state.

The program under the FROB was compared to the U.S. Troubled Asset Relief Program (TARP), and like with the U.S. banks, the money would help the Spanish banks get back on their feet.

Subordination of the Spanish state to the European Union can be shrugged off, according to Tchir. However, Tchir doesn’t provide reasoning beyond his statement that the situation is “being overly hyped.”

Lastly, the Business Insider article suggests that there is “new ideology in European crisis management: While EU leaders could have subjected Spain to a very embarrassing government bailout, instead they are realizing the necessity of mutually accepting the burden of Spain’s banking system.”

Bailout Desperation

“How desperate are things that they’re making such a large move so quickly?” Phoenix Capital Research asked.

Why the sudden haste, especially since Spain started talking about a bailout only this month? It appears that over the past year Spain’s political establishment rebuffed any suggestion that a bailout would be necessary. The Spanish government had not openly admitted to financial shortfalls.

For example, the partially nationalized Spanish bank Bankia, formed by consolidating several regional banks in 2010 and nationalized in May, has asked the Spanish government for 19 billion euros (US$24 billion) in bailout funds. In May, Bankia published its revised 2011 results showing a 3 billion euros (US$3.8 billion) loss, instead of a 309 euro (US$390 billion) profit.

The Phoenix Capital Research article said point blank, “The point I’m making here is that both the Spanish Government and the Spanish Banks will play ‘extend and pretend’ as long as possible right up until they’re on the brink of collapse.”

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