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Tuesday
Jul242012

The Extortion Racket Shifts to Spain

After 21 summits to save the euro, followed by dog-and-pony shows to calm the markets, followed by confidence-inspiring pronouncements about insurmountable firewalls and pandemic structural reforms, the euro is in greater danger than ever before. Spanish Prime Minister Mariano Rajoy walked away from the last summit at the end of June with a victory smile, and Italian Prime Minister Mario Monti was so triumphant that it aggravated other heads of state. Now, Spain is on the brink. Its collapse would be so spectacular that people have stopped watching Italy for now.

Despite repeated assurances that Spain would not need a bailout, though it already accepted €100 billion to bail out its banks, rumors floated to the surface Monday that it would seek a bailout. The price: €300 billion. This would be the topic in Berlin on Tuesday where Spanish Economic Minister Luis de Guindos would meet German Finance Minister Wolfgang Schäuble, the lynchpin in any of this. True to bailout form, de Guindos denied the rumors and emphasized again that Spain would not need a bailout.

Spain is desperate. Yields on 10-year bonds hit 7.5%, approaching the point where the high cost of borrowing would lock Spain out of the credit markets. But in October, €28 billion in government debt will come due. Hence de Guindos’ mission in Berlin.

But Tuesday morning, new rumors seeped out: de Guindos would push and shove Schäuble to allow the European Central Bank to buy Spanish debt in the secondary markets; it would force down yields and preserve Spain’s access to the markets. The government, with support from its triumvirate partners France and Italy, has been castigating the ECB that it wasn’t doing its job, which was to print money and buy sovereign bonds, something it had done before, but had inexplicably stopped in mid-March, and it fingered the behind-the-scenes culprit: Germany.

If de Guindos couldn’t persuade Schäuble to give in, “sources” of el Economista said, he would seek a temporary line of credit, not a bailout, to deal with Spain’s “temporary problems,” namely its maturing debt, funding its deficit, and bailing out its regions—Valencia, Murcia, and Catalonia already asked the central government for help. The line of credit would buy time—the mantra in all Eurozone bailouts. And if he couldn’t hoodwink Schäuble into agreeing to a line of credit, “sources” suggested that more “forceful measures” must be studied....

Default. Because Spain has no money to meet its upcoming obligations in October. Then there would be haircuts, the “sources” said. Dreadful words. It worked for Greece; it’s going to work for Spain. Given the amount of Spanish debt and related derivatives decomposing in closets of German banks, those words were a loaded gun to Schäuble’s head.

The extortion racket, perfected by successive Greek governments, has switched to Spain. But this alternative is so extreme, the sources said (thus putting the gun back into the holster for now), that it isn’t the most likely option. Nevertheless, Spanish Credit Default Swaps jumped 31 basis points to a record of 636.

Suddenly, plot twist. Meeting over, a new rumor bubbled up: the Germans wanted Spain to formally request a ... €300 billion bailout! It might fund Spain for a year and a half or so—to buy time. €100 billion would come from the current bailout fund, the EFSF—which would leave it with only €38 billion, after its commitments to Spain, Greece, Portugal, and Ireland, and possible commitments to Cyprus. €200 billion would come from the permanent but still non-existing bailout fund, the ESM; it’s still awaiting the rubber stamping by the German Constitutional Court. Apparently, de Guindos and Schäuble agreed that both funds could buy Spanish debt. Schäuble, however, didn’t yield on one item, despite the big gun to his head: the ECB would not buy Spanish bonds.

The conditions linked to the bailout package haven’t been determined yet. However “sources“ close to the government believed that no harsh conditions would be imposed, based on the structural reforms announced two weeks ago and those already implemented—measures that caused demonstrations, protests, and some violence across the country.

Given how bailouts have gone so far, the combined €400 billion won’t be enough, and it will probably be clear that it won’t be enough before the ink on the deal is even dry. Just like Greece now needs a third bailout, which it is unlikely to get, Spain’s final bailout costs will be far larger than the €400 billion, and far larger than any of the prior bailouts. And then there’s Italy. Read.... But Who The Heck Is Going To Do All The Bailing Out?

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Reader Comments (2)

Apparently you are unaware that it is constitutionally illegal for the ECB to buy debt in the primary market. It needs a few more people than just Schaeuble to change this. More precisely, it needs the approval of very single Eurozone country. Furthermore, the ECB is an independent institution. Neither Schaeuble nor any other FinMin have any say over it.
July 25, 2012 | Unregistered Commenternevermore
Nevermore - I'm completely aware that the ECB isn't allowed to buy gov bonds in the primary markets. Technicality: this isn't governed as you said, by a constitution, but by treaties.

I've written extensively about the ECB's limitations by treaty to monetize debt. In theory, the ECB is even limited in buying gov bonds in the secondary markets - though obviously it has found a way around it.

A treaty change that would allow the ECB to massively buy gov bonds in the primary and secondary markets would immediately stop the debt crisis (as the Fed has done), but any efforts in that direction runs into opposition from northern euro countries. If they agreed (unlikely), the consequences would be more insidious than the debt crisis because of the different economic and monetary needs and philosophies of the Eurozone's 17 countries.

I do agree that any such change (treaty change) would require unanimous agreement by all members.

However, French, Italian, and Spanish politicians (among others) have come out strongly in favor of the ECB buying in the secondary markets. AND: Hollande in his campaign had promised to do what he could to get the ECB to fund struggling governments directly, bypassing the markets altogether. He wanted to get a movement going in that direction (treaty change). He has since abandoned that track. Check out my posts on the French presidential election.
July 25, 2012 | Registered CommenterWolf Richter

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