What does the latest Spanish bail-out mean? Buy Europe
John Stepek Jul 10, 2012
That didn’t last long.
The traditional burst of market euphoria that normally follows eurozone summits has worn off already.
The European Union might have thought it had seen off disaster. Spain was meant to be having its banks bailed out directly. And there was the prospect of the European bail-out fund buying sovereign debt too.
And yet Spanish bond yields soon ran back up to around the 7% mark. So there’s been another emergency discussion session which ended this morning.
So here’s the big question: is another eurozone disaster looming?
The answer might surprise you...
The Spanish economy doesn’t look pretty
Spain’s in a mess. It costs the country around 7% a year to borrow over ten years. It costs more than 5% to borrow over two years. It has rampant unemployment, and the fallout from its property bubble has left its banking sector with huge potential bad debts.
Spain’s big problem is not public spending as such. It’s that the government can’t afford to prop up its banking sector. They might be ‘too big to fail’, but they’re also ‘too big to save’ – for Spain alone at least.
The big breakthrough at the EU summit was the idea that the eurozone bail-out fund would recapitalise the banks directly. By bypassing the Spanish government, Spain’s sovereign debt burden would remain manageable.
It would also avoid the problem of eurozone bail-out loans taking precedence over any other lenders. So lenders to Spain needn’t fear being stiffed in the same way that lenders to Greece were.
Of course, it’s one thing to say that the bail-out fund would recapitalise banks directly. Making it happen is quite another thing. And after the initial summit, it all started to get a bit blurry.
For a start, the Finns and the Dutch weren’t keen. They argued that “Madrid would still in some form be liable for the €100bn of loans on offer for Spain’s banks”, as the FT notes.
Over and above that, this direct recapitalisation can’t happen until there’s a pan-European banking supervisor. In other words, there needs to be one regulator to rule them all.
Why’s that? Mainly because if the crisis has taught us one thing, it’s that national regulators tend to be a bit soft on their banking sectors. (That lesson extends beyond the eurozone, clearly). If the whole eurozone is agreeing to take on liability for a national banking sector, they want to be sure that it’s a tough Europe-wide regulator who’s setting the rules, not a compromised national one.
So they’ve had another meeting this morning to try to iron some of this stuff out.
They’ve now agreed that Spain will get an emergency €30bn by the end of this month (assuming that the various governments agree).
While the Spanish government will be liable in the first instance, eventually – once the Europe-wide supervisor exists – the loans will be converted into direct cash injections into the banks.
Of course, given how long things take in Europe, and the hostility of various parts of the eurozone to the idea of shared liabilities, a single banking supervisor could be a long time coming.
Meanwhile, Spain has also been given more time to get its debt-to-GDP ratio down. In other words, it won’t have to be as ambitious with its austerity measures.
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The European project looks set to trundle on
So where does that leave Spain in the meantime? Will this be yet another short-lived sticking plaster bail-out? Probably.
But the key is, there’ll be another sticking plaster after that, and then another after that. For all the talk of bond yields breaching 7%, it’s important to understand that Spain is not Greece. Greece hit the point where it was in danger of genuinely running out of money, and having trouble paying for public services.
As the FT points out this morning, Spain can “in theory, keep refinancing its debt at current prices for some time, particularly if it mainly sells more short-term bills and bonds, yields on which are still substantially lower than they were during last autumn’s turmoil”.
And most Spanish mortgages are pegged to the Euribor (the European version of Libor – yes, it was fiddled too, in case you’re wondering). In other words, rising Spanish bond yields don’t really impact on borrowing costs for households.
Hans Lorenzen of Citigroup tells the FT that rising borrowing costs would likely make Spanish banks crack down harder on lending. But I suspect that credit is already so tight – and demand so low – that it makes little difference.
The point is, Europe has shown that it’s not willing to let Spain go. That suggests that it will continue to do what it takes to save it. And there’s enough breathing space available to let the slow-but-sure process continue to roll on.
Yes, Greece may well throw another spanner in the works in the future. But the more time the eurozone buys to circle the wagons, the less important Greece becomes.
In short, while I’m not convinced the euro has a long-term future, I think it’ll stagger on for a while longer. Of course, it’ll probably be weaker. That’s what you’d expect if the whole zone agrees to share liabilities. But this could also be good news, certainly for Germany, which is ultimately the backbone of the region.
This is one reason why we’re becoming increasingly interested in battered-down European stocks. The other reason is that they’re cheap. And the best way to make money in the long run, is to buy stuff when it’s cheap. You can read more in our recent MoneyWeek magazine cover story on Italy: Why it's time to pile into Italian stocks. And for other ideas on eurozone stocks to buy, read our recent Roundtable here: The 17 investments our experts would buy now. (If you're not already a subscriber, claim your first three issues of MoneyWeek free here.)
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