viernes, 20 de abril de 2012

The Spanish conundrum: why Spain will need to be bailed out for doing what it is supposed to do to avoid being rescued

The problem in Spain, in the big scheme of things, was never one of public expenditure, but private and financial debt, subsequently nationalized. The famous Irish syndrome. The financial sector deconstruction is the big elephant in the room. Who will dare to tell shareholders, bond holders and management that their party is over?. Ireland was brought down due to Dublin's stubborn stand to repay bond holders… In Spain they insist on protecting the owners and the leaders of the banks. The additional problem in Spain is that much of the junior bank debt (and stock) has been sold to orphans and widows in the branch networks and with the necessary cooperation of Bank of Spain.

As, to start with, we did not have a massive sovereign debt problem (at least in relative terms), trying to get ourselves out of a fundamentally private and financial debt problem through an austerity shock in public expenditure creates unintended consequences (accepting that will not make you a member of any Keynesian sect). Cleary, the austerity is cutting into productive muscle. But, to make matters worse, most of the public expenditure (and debt) occurs outside of the direct Spanish Central Government control (Regional Governments) whilst, indirectly (and more and more directly) the central Treasury guarantees the regional debt. Crazy. For a real rationalization, the whole constitutional equation of the regional devolution needs to be addressed. That would require wide political consensus. Good luck. In summary: what the politicians are not capable to do to the bankers, they will not be willing to do it to themselves.

In addition, there has been a leadership gap and a shortsighted approach in the new Government. Rajoy’s administration reached power as if caught by surprised, unprepared. And their only plan seems to be to follow blindly the German guidelines, that in the short term are counter to Spain's interests. Of course we need fiscal conservatism in the long term, but our problem not being public expenditure, the impositions from shortsighted Germany are creating an impossible conundrum: as Spain's Government is doing what it is told to do, consumption and growth is massively affected, creating unemployment, that in turn affects also expenditure (subsidies), that worsen the cost of the debt and jeopardizes the service of the existing one, which in turn further deteriorate public finances. So, the market are penalizing the Spanish government's conformity.

After all, maybe the Germans are not that shortsighted: as major holders of our sovereign debt, they are reducing their share by having Spanish banks buying the new bonds. And the Spanish banks are doing that with ECB money… yes, some of it German, but widely shared across Europe. Interesting German way to share the pain while pontificating…

There are a number of additional problems:

-    An international credibility gap: in Spain nobody has gone to jail, no region or town hall has been intervened, no Botín has lost his bank. No Governor of Bank of Spain has been forced to resign and declare on a Parliamentary inquiry on his mismanagement.

-    An internal understanding gap: the mistrust on the maturity of the population means that Rajoy has not gone on tv prime time to address the nation on the reality of the situation, where we are, why, what we must doing, what that means and where we are going. I think a fundamental difference between Spain and Italy or Greece (and, to some extent France) is that we can take it in the chin, apretar los dientes and deal with it. The domestic result of this communication and leadership fiasco is massive disenfranchisement with the institutions of the country (and the civil society hardly exists), which for a young democracy in trouble is extraordinarily dangerous

-    A strategic gap: if an economy is dealt with as a runoff entity, not a lot of people will want to buy into it. Only scavengers. The best you can hope for is sweating the assets until they bleed. You need to apply the concept of a going concern: you need growth. Even a minimum level of new private debt, healthier, that substitutes the old one. No Credit at all is suicidal. The Italians have done that better: they have an austerity program (with an opportunity for massive yield as they were much more inefficient than us) and a growth program. And, of course, being Italian, they put fancy brand names to each.

I am convinced the Germans have a plan. Their plan is a more Federal Europe under their leadership with the survival of the Euro (they cannot afford otherwise). For that, a rescue package for Spain is becoming inevitable. The only way to make that politically palatable to the German electorate is for Spain to relinquish big time its sovereignty. Funny, as the best managers for that package and hence best protectors  of the German interests would be… the current Spanish Government, that would suffer a massive blow should an intervention occur. That, a bailout, is clearly the base case now. The question is the timing.

Rajoy, as the obedient pupil that memorizes everything without fully understanding it and then does not get the best marks, looks numbed, puzzled and frustrated, not understanding that the times require independent thinking and political leadership. Starting with grabbing the German Chancellor by the balls (yes, her balls) and telling her, like in the old joke, that"we are not going to hurt each other". The fact is that Spain could ultimately derail the European dream, and the Spanish Government should not allow itself to be bullied, to be forced to take a rope and hang itself. Spain is not Greece or Portugal. 

Some strong signals are needed to rally the country: a PM speech national tv (the speech of his life), the intervention of some regions, the dismissal of the Central Bank Governor and sending some people cuffed to jail in front of the cameras would be the beginning of a turning point.

However, that would all be a futile exercise if the fundamental financial sector reform is not decisively confronted, with the result of pain for shareholders, bondholders and management.

The Spanish financial system needs no less than €200Bn, only to take care of bad debt underprovisions. If we talk about the dramatic situation of the €374Bn in covered bonds (interesting recent Moodys' report... Scary magnitudes. As said, we need to grab the mic, but we also need to regain credibility and the Government keeps avoiding a financial re-capitalization that will make some form of recue inevitable.

And all those figures are just to take care of the mess in force. The regulator needs to add to the credibility journey by preventing banks originating the kind of trash subprime the continue producing (today!!) in order to sell the housing stock in their books. And it should force the banks to adjust their Risk Weighted Assets tpo reflect, not a historic perspective of risk, but a current one. Instead, we witness continued, appalling collective irresponsibility. 

In this negative loop, kicking the can forward seems to be the only plan in that endogamic entente between banks and government: most of the newly issued Spanish sovereign debt is being bought by these same banks with the ECB liquidity (and by the national pension system). No credit gets to the productive sector, banks make money with the dope of the carry trade, whilst they continue paying dividends and are allowed not to mark assets to market values. That is what any outside in observer would see in Spain: the collective leadership of a country unwilling to face reality.

There is no substitute: assets need to be marked to market and losses reserved for: that will create a massive equity shortfall, the entities will need to be capitalized with public money, hence the rescue. A national humiliation and a massive generational failure. Only then fresh foreign capital will be attracted and we will start our crossing of the desert.