Spain Tries To Preempt the Conditionality Debate
Many observers agree that Spain has the rest of the euro area, specifically paymaster Germany, over a barrel: if it were to leave the common currency in order to inflate itself back to prosperity, as ruinous as such a decision would likely prove to be, it would probably precipitate the end of the euro.
This is apparently also the opinion of Spain's government. After having dawdled since the GFC and having failed to seriously deal with its insolvent banks and the implementation of a rigorous economic reform program, the Rajoy government now is trying to preempt the ECB by issuing demands regarding the shape and form of its upcoming bailout.
As Reuters reports:
“The European Central Bank must take forceful and unlimited steps to buy sovereign debt to help Spain reduce its refinancing costs and eliminate doubts over the euro zone's future, Spain's economy minister said in comments published on Saturday.
"There can be no limit set or at least (the ECB) can't say how much they will use or for how long," when it buys bonds in the secondary markets, Luis de Guindos told Spanish news agency EFE.
The Spanish government will study the details of the ECB's debt-buying program, which are likely to be outlined before the Eurogroup meeting mid-September, before making a decision on applying for more European aid, de Guindos said.
In response to a renewed intensification of the debt crisis, ECB President Mario Draghi said on August 2 the ECB may buy more government bonds, but only once countries had turned to the bloc's rescue funds for help and agreed to strict conditions.
"I believe Spain has presented its budget adjustment program and its structural reforms, which from a general point of view, have been accepted as sufficient and appropriate," de Guindos said.”
In other words, what they want is an unlimited bailout in the form of central bank buying of their bonds (naturally this is will be done with money created ex nihilo), with absolutely no conditions attached, on the grounds that the steps taken thus far are already more than enough. This is obviously an opening gambit to the upcoming talks in mid September, designed to make it perfectly clear to those insisting on conditionality that Spain doesn't intend to give up control over its fiscal policy in exchange for the bailout.
There have been several occasions when Spain has had its way in the past – recall for instance the EU's back-pedaling on the deficit targets. Very likely a lively debate took place behind closed doors, garnished with threats.
At the same time, German news magazine Der Spiegel reported on a putative ECB plan to set caps on peripheral interest rates (which once again would only work if the central bank threatened to engage in unlimited buying of the debt concerned). This was immediately denied by the ECB itself, with the somewhat cryptic remark that it was “absolutely misleading to report on decisions which have not yet been taken and also on individual views, which have not yet been discussed by the ECB’s governing council”.
The remark is cryptic because it is not a clear no – however the German government let it be known that it too was unaware of such a plan, with a finance ministry spokesman saying that “In purely theoretical, abstract terms, such an instrument would certainly be very problematic. But I know of no proposal along these lines”.
In 'purely theoretical, abstract terms'?
Then the German Bundesbank chimed in via its monthly report, reiterating its opposition to all kinds of sovereign bond buying by the ECB, regardless of 'conditionality' and whatnot. Some of the words from the Bundesbank's missive are worth quoting:
“Decisions on whether to share solvency risks much more widely should be taken by governments and parliaments."
“The Bundesbank holds to its opinion that government bond purchases by the Eurosystem in particular are to be seen critically and are linked to considerable risks to stability."
Moreover, “moves to create a single euro-zone banking regulator, as envisaged by the European Commission, shouldn't transfer solvency risks among member states via aid for banks.”
It couldn't be any clearer that Jens Weidmann is almost as implacably opposed to the central bank straying into the fiscal realm as his predecessor Axel Weber was. The big question is whether this means he will simply continue to be outvoted at the ECB, or whether Germany's political leadership is already sawing on the limb he has climbed out on. Although German ECB board member “Nobody should try to create the impression that the Bundesbank or its president are isolated”, Weidmann sure does look isolated at this point.
The rumors and denials yanked both interest rates and stock markets to and fro in European trading on Monday – which is actually business as usual in the euro area.
Spain's 2 year note yield on Monday – yanked around by rumors and denials – click chart for better resolution.
Spain's NPL's Soar, Banks Run Out of Collateral
Meanwhile, now that it has been decided that the euro area's bailout mechanisms will pay for the clean-up of the Spanish banking system, NPL's have begun to jump higher in a rather impressive increment and have finally reached the long expected all time high, clocking in at 9.42% of all outstanding loans as of June.
A long term chart of Spain's NPL's via Scott barber of Reuters. A new all time high of 9.42%, while 'doubtful' loans are approaching 25% – click chart for better resolution.
Concurrently, the borrowings of Spain's banks from the ECB have soared to a new all time high of €411 billion as at the end of July – and the banks have now finally run out of collateral to pledge. Reuters reports that 'Spanish banks are next for a Greek-style ECB shakedown', in reference to the growing use of 'ELA' (emergency liquidity assistance) en lieu of normal ECB funding.
In this manner the ECB shifts the risks back to the Bank of Spain and ultimately the sovereign – in theory, anyway. One should not lose sight of the fact that what the Bank of Spain does when it extends ELA funding is that it prints euros and not pesetas. Therefore it would be more realistic to call this a risk borne by all users of the euro, as a future write-off of the assets the BoS gets in return for extending these funds could potentially leave the newly printed money stranded in the economy. These assets are little more than IOU's issued by the banks themselves, although sometimes imbued with a government guarantee. In Greece's case the guarantee is issued by an insolvent government. In Spain the same could soon be the case.
Something that is often overlooked when discussing Spain's NPL's as a percentage of outstanding loans is how big the credit bubble actually was and how much bigger therefore the amounts involved are compared to the 1994 peak in NPL's. This can give us an idea what the only just beginning deleveraging phase of the credit bubble will actually entail. Not to forget, NPL's remain a moving target, as both residential and commercial real estate prices continue to decline. As the FT reports, transaction volumes in commercial property markets in both Italy and Spain have collapsed by over 90% in just the past three months.
A long term chart of Spain's NPL's in billions of euros, via Querschüsse.de – click chart for better resolution.
Private Sector Credit Growth Goes into Reverse, Bank Balance Sheets Expand Anyway
The credit bubble in Spain has finally begun to deflate – private sector bank credit growth has turned negative in recent months. It may be a long and thorny road before the deleveraging process is finished.
As of June, the cumulative decline in private sector loans stood at €54.3 billion (via the WSJ)
To put this decline in private sector credit into perspective relative to the amount of credit extended during the boom, a look at a long term chart is once again instructive:
Total bank credit extended to the private sector in Spain – as can be seen, the 1993-1994 credit crisis did not lead to any deleveraging at all. This time, things are different and given the likelihood that up to a quarter of the credit outstanding is unsound, there may be a long way to go indeed (chart via Querschüsse.de) – click chart for better resolution.
Interestingly though, the balance sheets of Spain's banks have not shrunk – instead they have actually reached a new all time high in June. How can this be explained? The only reasonable explanation we can think of is that Spain's banks have bought so many government bonds this year that the extension of credit to the government has handily exceeded the negative growth in private sector credit.
Spain's bank assets in total now amount to over 400% of nominal GDP, having risen to €4.33 billion in total.
The balance sheets of all reporting MFI's in Spain have reached a new all time high – bank assets amount to over 400% of Spain's GDP – click chart for better resolution.
Investors Are Hearing What They Want to Hear
In his weekly missive John Hussman has pointed out in the context of Angela Merkel recently reiterating her support for the ECB's plan, 'investors have stopped actually listening for fact, and are increasingly hearing only what they want to hear'.
If you still require proof that in the short term, market action is driven by perceptions and sentiment rather than reality, here it is. It is worth quoting again what Mrs. Merkel said in Ottawa in toto:
“The European Central Bank, although it is of course independent, is completely in line with what we’ve said all along. And the results of the meeting of the central bank and their decisions, actually shows that the European Central Bank is counting on political action in the form of conditionality as the precondition for a positive development of the Euro.”
Does this sound like 'unlimited bond buying without preconditions' to anyone? No? Investors seemed to think that is what it meant. We see no painless way out for Spain, regardless of what ultimately happens. Even if the ECB were to act without conditionality or limits, it could not possibly alter the underlying solvency problems – and this isn't going to happen anyway. So what are markets currently pricing in? Everybody seems quite certain of a happy end at the moment. The bet is that massive central bank intervention is heading our way in the near future and will boost asset prices further. This is a mindset that has very likely set up the markets for disappointment.
Positioning of speculators in US stock index futures (all index futures, weighted) shows the biggest net long exposure in more than a year – click chart for better resolution.
Meanwhile, one likely source of second thoughts remains China, the stock market of which has just fallen to a new post-bubble low:
The Shanghai Composite stock index continues to grind lower – click chart for better resolution.
Charts by: BigCharts, querschüsse.de, WSJ , Reuters, Sentimentrader
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