The Catalonian Blunder


(A terrace overlooking Barcelona)


“Here, are you happy, Alice?”


“Happy? In Spain? With you?”



('The Catalonian Blunder', from 'Instant Lives' by Howard Moss)


We've been waiting since last July for an opportunity to use that one again. Spain has just provided it. In October 2011 we noted that the Zapatero government's uncanny knack to meet Spain's fiscal targets was slightly suspicious. We opined at the time that it appeared as though it was using a simple accounting trick, namely of shifting the deficit to the regions by cutting remittances to them by 16%.  We recently asked Edward Hugh, who's a noted expert on Spain's economy, whether this was indeed the correct interpretation and he confirmed it.

Today more confirmation came via a Bloomberg report entitled “Spain’s Rajoy May Need Back Door Bailout for Regional Rescues” – in other words, the deficit is now shifting right back to the center:


“Prime Minister Mariano Rajoy may need to skirt Spanish law to backstop the nation’s indebted regions, mimicking the European Union’s dodging of its no- bailout rule to save Greece, Ireland and Portugal from default.

“We consider the Spanish government should guarantee or take responsibility for the debt it has authorized the regions to issue,” said Albert Carreras de Odriozola, Catalonia’s deputy finance chief, in a telephone interview. “It must be possible to talk and find a mechanism.”

Catalonia, Valencia, Andalusia and Madrid, which account for 60 percent of Spain’s economy, are shut out of markets as they brace to repay 9 billion euros ($11.5 billion) to lenders this year, according to data compiled by Bloomberg. Spain’s 10- year yield has risen to 5.3 percent from 5.09 percent on Dec. 30 when the government said its 2011 deficit had ballooned to a third larger than its target.

Regional shortfalls drove Spain’s deficit to 8 percent of gross domestic product, breaching the 6 percent pledged to the EU. Spain’s Parliament today examines 15 billion euros of tax increases and spending cuts announced by Rajoy’s government on Dec. 30 to compensate the slippage.

“Rajoy cannot afford for regional governments to fail,” said Michael Derks, chief strategist at FXPro Financial Services Ltd. in London. “What Rajoy may well need to do is to provide a limited guarantee on regional funding, on the proviso that those regions who take advantage of the guarantee sign up to fiscal reforms.”

The yield on 2020 bonds of Catalonia, the wealthiest region with an economy the size of Portugal’s, reached 9.738 percent today compared with 5.029 percent for similar maturity Spanish government debt.


(emphasis added)

Yep, it sure sounds like a Catalonian blunder. You have to love this free-for-all throwing around of slightly odious terms in just the first few paragraphs: 'back door bailout'; 'skirt the law'; 'dodging the rules'. Followed later by the ominous sounding  'shortfall', 'broken pledge' and last but not least, 'slippage'.

The whole thing has a slightly Greek odor about it. The old government goes, and as soon as the new one comes in, it turns out the book-keeping of the old one was all smoke and mirrors. Only in this case it was obvious to all with eyes to see beforehand.


“Valencia, with the highest debt-to-GDP ratio among the regions, saw its credit rating cut to non-investment grade by Moody’s Investors Services last month, and was forced to delay repayment of a 123 million euro loan to Deutsche Bank AG for a week.

Catalonia has asked for a delay in handing tax payments to the central government. It also suggested Madrid guarantee regions’ debt sales to attract lenders.“


OK, so it's the Valencian-Catalonian co-blunder.


The Mothers of Invention in 'Wait and Pray'

As our readers are probably aware, the former government of Spain wasn't the only creative accounting enterprise in Spain. The Spanish banks are past masters at the art of sweeping things under the rug, by sheer necessity in view of the burst housing bubble. Surrounded by ghost towns, buried in NPL's, bereft of funding – survival is often a matter of who's telling the best lies most convincingly.

Creative thinking comes at a premium, and one cannot accuse Spain's banks of lacking in that particular department. Now they're trying their hand at real estate development, this is to say, they have become builders, building  new homes smack dab in the middle of a historic housing glut.


According to the WSJ:


“On a weedy dirt lot here, lender Bankia is pursuing its answer to a banking and property crisis that has left Spain with a glut of around one million vacant homes. Its approach: Build even more.

Bankia and a local developer plan to build a 212-unit housing complex featuring a gym and movie theater on the central Madrid site where a bus station once stood. Construction begins early this year, even though sales of existing properties are practically nonexistent and only 45 of the planned new units have been sold in advance.

"The market is at a standstill," said César Cabal, a real-estate broker working with the developers.

The drive to keep building in a housing market drowning in empty properties shows the depth of Spain's banking crisis. The country's housing bust saddled banks with not just vacant homes, but also billions of euros worth of undeveloped land.

Yet rather than writing off the land as a loss and attempting to sell it, Bankia and its peers have begun selectively building on empty lots. In some cases there are buyers lined up but in other cases there aren't.” [you don't say, ed.]


(emphasis added)

Yes, we had to blink too. A few more snippets:


“A Bankia spokesman said the bank is building only in high-demand areas, like central Madrid, and that the new projects are a smart way to give a dud asset new value.

There were about 700,000 vacant newly built homes at the end of 2010, the most recent numbers available, according to Spanish government figures. Including repossessed properties, some economists and real-estate consultants estimate the total could be as high as one million, or even 1.5 million.”


“Lenders are hoping that the moribund Spanish property market will pick back up. But that is hardly a sure thing in a country with more than 22% unemployment and uncertain growth prospects.”


Even meager home sales could benefit certain lenders in Spain. But there are concerns that building more homes will drive prices down further, compounding the problems of the housing market, and by extension, the banking sector. [gee, could it be? ed.]

Since its property bubble burst in early 2008, the Spanish financial sector has been dogged by fears that it has put off doing a deep clean of the estimated €176 billion ($224 billion) in troubled assets sitting on its books. Banks have set aside funds to cover about a third of that amount.


Unless the now-struggling banks start generating enough profits to absorb these losses, the sector could face a state-backed or international bailout, said José García Montalvo, an economics professor at the University of Pompeu Fabra in Barcelona.


(emphasis added)

Well, a 'state-backed bailout' has become somewhat less probable in view of the new government debt arithmetic due to the aforementioned regional back door bail-out surprises, which mean that the fiscal target has become but a distant dream. Senor Montalvo actually summed the situation up nicely:


“Spain's strategy has been 'wait and see. We'll inject money but little by little,'" said Mr. García Montalvo. "We are no longer in 'wait and see.' Now we are in 'wait and pray'.”


(emphasis added)

The problem of having swept everything under the rug gets a mention as well – and it seems that building houses on vacant lots is actually among the methods employed for this purpose:


“Graham Neilson, chief investment strategist at Cairn Capital Ltd., a London-based fixed-income asset manager, said many banks still are carrying real estate at unrealistic valuations on their books. "Some of these assets are close to worthless but have not been marked as anywhere near to that," he said.”


Analysts and investors say that the practice of building on empty lots is one among several moves that have helped banks obscure the size of inevitable losses. They say that banks also have been refinancing loans to developers that in many cases have little hope of paying them back.

Spain's banks have €338 billion in exposure to the real-estate sector, mostly through loans to developers, according to Bank of Spain data. This number has hardly budged in the past three years, despite a wave of developer bankruptcies following the property market decline.

Joaquín Maudos, a professor of economics at the University of Valencia, said that statistic indicates banks are continuing to refinance loans, instead of writing them off. "They are putting makeup on these bad loans," he said.


(emphasis added)

Putting lipstick on a pig, as they say. But wait, it gets still better:


“A division of Sergesprom 2000, a struggling midsize developer in Catalonia, is one example. It received about a €30 million loan from a local savings bank to build 200 homes during the property boom. But the market collapsed, and Francisco Gómez, the building firm's chief executive, said he hasn't been able to sell the homes, or even pay interest on the loan, for the past three years.

Instead of foreclosing, he said the bank—which he won't name—has been lending him more money to cover the interest payments, adding an extra €3 million to the total debt. Mr. Gómez isn't confident he can pay it off.


Yet another Catalonian blunder it seems.


Spain's real estate problems in pictures, via the WSJ. In the bubble's peak year, Spain built more houses than the UK, Germany and Italy combined – click chart for better resolution.



Industrial Production Plunges

In related news, it was announced that Spain's industrial production fell by 7%, far more than expected and at the fastest pace in 26 months.


“Spain's industrial production fell at the fastest pace in 26 months in November, adding to evidence that the economy contracted in the final quarter of last year.

Industrial production dropped a working-day adjusted 7 percent year-on-year, after falling 4.2 percent in October, which was revised from 4 percent, data from the statistical office INE showed. Economists had forecast production to decline 5.4 percent in November.

The latest decline was the worse since October 2009, when production tumbled 9.1 percent. Industrial output fell for the third month in a row, after stagnating in August.

A 16.3 percent plunge in the manufacture of consumer durables led the decline in overall industrial production. Non-durables output fell 2.8 percent. Consumer goods production dropped 4.4 percent.

Production of capital goods was down 7.4 percent, while manufacture of intermediate goods fell 10 percent. Energy output decreased 5.2 percent.”


That doesn't sound particularly encouraging considering unemployment stands at nearly 23%.


Credit Market Charts

Below is our customary collection of charts updating the usual suspects: CDS spreads, bond yields, euro basis swaps and several other charts. Charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Wednesday's close.

Generally, things looked a tad better again, in spite of Fitch's apocalyptic warnings.

CDS on Japan are still trending higher however, in short they are currently becoming uncorrelated with euro area CDS – in a bad way.

CDS on Hungary are also veering off in the wrong direction again (as to why, see the addendum).

Interestingly, investors seem not overly worried about all the bad news emanating from Spain – Spanish government bond yields and CDS fell further. Maybe people are figuring it's so bad it can't get any worse?



5 year CDS on Portugal, Italy, Greece and Spain – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – click chart for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – click chart for better resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – small dips R us, for now – click chart for better resolution.



5 year CDS on Romania, Poland,  Lithuania and Estonia – click chart for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – they all still look like ascending triangles – click chart for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns. Consolidation below resistance for the SovX? – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps – a big recovery on Wednesday – click chart for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – another tiny dip – click chart for better resolution.



5 year CDS on two big Austrian banks, Raiffeisen and Erstebank – ditto – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – Spain's bonds remain in fashion in spite of the above mentioned revelation about the regions. It seems the new government is given the benefit of the doubt for now – click chart for better resolution.



The 9-year Irish government bond yield, the 2 year Greek note yield, and the yield on UK gilts and the Austrian 10 year government bond – all lower – click chart for better resolution.



Hungary's 10 year note yield – a small bounce – click chart for better resolution.



5 year CDS on the debt of Australia's 'Big Four' banks –  a small dip – click chart for better resolution.



Addendum: Eurocracy Steps on Hungarian Toes

There's not a dull moment in the Puszta anymore. Now the eurocrats have decided that Hungary's insubordinate government is in need of a disciplining and have singled Hungary out as the first country in line for punishment according to the new fiscal rules, employing  the expanded powers Brussels nowadays enjoys. In fact, the EU delivered a veritable broadside.

Viktor Orban won't be happy – but then, who would be?

According to the WSJ:


“The European Union on Wednesday opened several new fronts in an intensifying dispute with Hungary, including a warning that the government is likely to face legal action if it doesn't change laws that critics say threaten the independence of key government agencies.

The European Commission, the EU's executive arm, also said EU subsidies destined for Hungary could be suspended starting next year if the government doesn't rework plans to cut its budget deficit.

Wednesday's measures mark a further deterioration in relations between the EU and Hungary, which have soured since the center-right Fidesz party of Prime Minister Viktor Orban took power in 2010.


Mr. Orban's budget plans also drew criticism from the commission, which said the country could see EU payments earmarked for poorer member countries suspended if it doesn't revise the plans. These subsidies could account for 1.7% of Hungary's gross domestic product in 2013, or roughly €1.5 billion ($1.9 billion), one EU official said, though others said the figure is uncertain.

Hungary in 2011 ran a government surplus that was over 3% of GDP, the best budget performance in the EU. The problem, the EU says, is the government has been balancing its books with measures—a one-time tax on telecommunications firms, for example—that don't translate into a permanent improvement in its budget balance.

"Hungary has taken measures but these are unfortunately not sufficient to correct the deficit in a sustainable and credible manner," said EU Economics Commissioner Olli Rehn.”


(emphasis added)

In fact it appears as though Hungary's special budget measures amounted to about a 10% of GDP swing in its fiscal performance in 2011, so the complaint highlighted above is not without merit.

Alas, the EU has apparently provoked a nationalistic backlash in Hungary.

As Bloomberg reports:


Hungary’s radical nationalist Jobbik party backs quitting the European Union after the bloc’s executive said it may sue Hungary for possible violations of the independence of the central bank, the judiciary and the data protection office, MTI reported.

Jobbik is defending “Hungary’s sovereignty” and not the specific laws, party leader Gabor Vona said yesterday, according to the state news service.

Jobbik has surged in polls and is now tied for second place among decided voters, pollster Szonda Ipsos said on Dec. 14”


(emphasis added)

Note that the poll was taken before the most recent altercation with the EU. Who knows, maybe the FIDESZ majority is not as secure as is widely believed.



Charts by: Bloomberg




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