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Tuesday, October 16, 2012

A virtual Spanish bailout?

In case you’re wondering, we not talking about a bailout on Facebook or the like.

No, we’re referring to the quite strange comments by a Spanish finance ministry official reported in the press this morning. The official reportedly stated that Spain does not see a bailout request as imminent or immediately necessary but would be comfortable making the request for a precautionary credit line in order to potentially access the ECB’s new Outright Monetary Transaction (OMT) programme. All par for the course you would say, but the comments that really caught our eye were the following, via the FT and the WSJ:
"The credit line is not fundamental, it is circumstantial…One could say it's a virtual credit line,” adding that Spain will likely not access any of the money from the ESM, while the ECB may not even have to buy any bonds. 
Let us elaborate, because this seems to amount to a bailout without any money. Essentially, the suggestion is that Spain would sign a new Memorandum of Understanding (MoU), which wouldn’t include any new reforms or conditions, allowing it access to ESM money if it ever became necessary. This would supposedly satisfy the OMT requirements allowing the ECB to intervene in the secondary market for Spanish bonds if borrowing costs for Spain once more reach unsustainable levels.

A very neat idea in theory, as with most eurozone proposals, but we have a few concerns:
  • We can’t imagine the ECB or Germany would go for it. Both would likely request stricter reforms and conditions (probably rightly, as we noted recently Spanish labour market reform has some way to go), particulary since it would need approval from the Bundestag. 
  • More importantly, this may fail the ECB’s conditionality requirement. Although, details on the OMT are thin on the ground, the conditionality needs to be enforceable. The conditionality comes from a MoU which is tied to the ESM financial aid. Therefore if the ESM aid is not actually being accessed the conditionality is instantly voided since it cannot be enforced by withdrawing funding (since the funding is non-existent). 
  • A strange situation could arise where the ECB is then buying bonds without the ESM lending money, while no new conditions have been enforced. We’ve warned of the moral hazard and other negative impacts of this at length before. 
  • If the ESM is not lending to Spain but the ECB is buying its bonds surely the MoU and conditions essentially become a direct agreement between the ECB and Spain, putting pay to the view that these actions relate to monetary policy and maintain the independence of the ECB. 
  • As the ESM guidelines on precautionary loans note, they are only available to countries where there are no “bank solvency problems that would pose systemic threats to the stability of the euro area banking system.” We’re sure this will be fudged, with the eurozone suggesting the bank bailout solves any remaining provlems, although we’d maintain that €40bn is far from enough to solve the problem.
  • This is not to mention that Spain has huge funding needs and will in fact need real cash injections at some point, meaning the threat of intervention will surely not be enough to hold Spain over. 
We’ll end with an interesting, if somewhat mixed, analogy from the Spanish official:
“One does not just normally drop an atomic bomb. It has to be co-ordinated and discussed. But we [Europe] are all in the same boat.” 
Quite. As we’ve previously warned the OMT and Spanish bailout needs to be carefully structured, unfortunately a 'virtual bailout' is unlikely to do the trick.


Bugsy said...

It seems that Spain wants the ECB to lend directly, rather than buy bonds. Wouldn't that make the ECB just a bank?

Anonymous said...

more precisely: a bad bank

Rik said...

Even Spain will not be so stupid to go for that as it would mean a clear violation of 123 (no bail out by ECB). One that even the ECJ could not fix anymore.

However we might see some suggestions like this by people that do not really have their eyes on the ball and are looking solely at their own political position in Spain iso meeting some pretty essential legal requirements. The problem the credit on the homefront shows up as a liability (chance some Court stops it) on the other side of the BS.

Anyway basically the markets posution re Spain is: donot get into deep as the ECB might start to buy. Without potentially ECB intervention it would be toast (and the black variety).
This is certain to get tested price of bonds is higher and considerably than their value when unsuported by ECB/EZ. So normal market parties will basically sell. Putting upward pressure on the yields and making more people nervous that start to sell etc.
First all normal market parties have to be out before dodgy bankrupt Spanish bank whose arms' are twisted by the local government can step in and dump the garbage at the ECB (repo). At least that is what Spain thinks if loger term acceptable in the North doubtful.
And there are still alot of normal parties in.

Big question is if the ECB can easily keep yields below basically EZ average or even the present yields. Imho that will be pretty difficult especially for the longer term bonds. If lateron the ECB would decide the country can stand on its own 2 feet it would be at 6-7% annual for 10 Y. That reflects in the price when there is ECB support. Basically what we see now but in the mirror. People expect ECB out in say 5Y and with yields going to 6-7% they will price that in.
Not even to mention the EZ/ECB stopping things because forced politically. Or Spain and Co not meeting targets. Or and that is shorter term transmission even with huge support doesnot work (as that is what going to happen of course) and it becomes very obvious that it is simply state financing with a very thin veil.

Anyway politically in the North this is not going to happen.

Italy markets are in doubt but are in their bipolar world clearly in an 'up' now. Very doubtful if that remains that way when it gets in a down again. Likely when Spain has to be forced by market pressure. Lousy combination for Italy. So they probably will be next on the block.

Idris Francis said...

And how many Angels really can dance on the head of a pin?

Its just words, being thrown around as if in a kaleisescope, hoping that next time they will form a pretty pattern that everyone will like. Or that no one will see through, at least not for the first 3 days.

Its nonsense, and trying to analyse it is pointeless.

Its like theatre critics analysis Waiting for Godot - each sees what he wishes to see, none agree ith anyone else. This parrot is dead.

Blankfiend said...

Having Your Cake and Eating It Too

The Spanish strategy for tapping into the ECB’s OMT program is becoming clearer. In a nutshell, the plan is to sign a Memorandum of Understanding with the ESM for an Enhanced Conditions Credit Line. Once these preconditions are met, the ECB has already compromised its independence by obligating itself to begin buying Spanish debt on the secondary market. Spain does not even have to take an advance on its ECCL – it just needs the MOU in hand. With that MOU, and no money outstanding on its ECCL, Spain gains tremendous leverage as a large debtor nation. At that point, it becomes a matter of the ECB’s resolve to enforce conditionality versus Spain’s potential inclination to take the ECB hostage.
Stay tuned…

Rollo said...

Don't worry: Hollande has just told us that the crisis is solved. So that's all right then.