Streetwise Professor

June 22, 2012

Spanish Bonds in Andalusia

Filed under: Clearing,Economics,Financial Crisis II,Politics — The Professor @ 12:03 am

The Bulava-esque trajectory of the “bailout” of the Spanish banks would be hilarious if it weren’t so tragic.  But it was predictably tragic.

The Euros pulled one of their characteristic delay and pray moves.  (Though, being thoroughly pomo, I doubt praying had much to do with it.)  In essence, they funded-maybe, because the details of the funding and the identify of the funder(s) are Players to Be Named Later-the movement of Spanish bank liabilities onto the balance sheet of the Spanish government.  This boosted the debt-to-GDP ratio of Spain to the severe pain range: uhm, bringing the SPVs on balance sheet doesn’t make the entity stronger; quite the contrary.  A level that is likely unsustainable given the dire economic straits the country finds itself in, with GDP contracting and unemployment at Great Depression heights.  Moreover, the move has affected the game between the EU and the other debtor nations, who see that Spain extracted a deal that compares favorably, in terms of “conditions” to theirs.  Thus, Ireland may want a renegotiation of its deal, and the Greeks may conclude that telling the Troika to eff off might be the best course.  Moreover, it gave those holding bonds not just in Spain but in other precarious countries-notably Italy-serious concerns that they might be subordinated.

Furthermore, by absorbing a big chunk of EFSF/ESM resources, the Spanish bailout raised serious questions about their ability to assist other countries, with Italy again at the top of the list.  This further increases the angst of bondholders. (A warning to CCPs that have resources to absorb the default of N members, but no means to recapitalize.  When the N-2d or N-1st default occurs, there is likely to be a run on the CCP, making its ultimate demise almost inevitable.)

Hence, after an initial burst of foolish EUphoria, Spanish bond yields spiked, as did those on Italian debt.

Well played!  Well played! Bravo!

No, Europe’s real choices, as opposed to its finger-in-the-dike stopgaps, are exactly the same as they were last year, and the year before that.  Amputation or gangrene.  Socialization of debt or dissolution of the Eurozone as it currently exists.

But Europe refuses to grasp those nettles.  Truth be told, moreover, it seems impossible that they can negotiate the arrangement necessary to make socialization palatable to those who are likely to be net contributors-notably, the Germans. Germany obviously does not want to be Europe’s ATM, and reasonably demands mechanisms that limit its exposure.  Furthermore, it is highly unlikely that the electorates of other nations are willing to surrender sovereignty, or undertake the structural reforms* necessary to make them competitive and put them on a reasonable growth trajectory.

Indeed, look at the delusional policies that France is pursuing.  Lowering the retirement age.  Looking to make it virtually impossible to layoff or fire anybody-which will mean that it it will be financially insane to hire anybody in the first place.  In the name of growth!  These policies are popular-not only did Hollande win, but the Socialists won an outright majority in the just-finished parliamentary elections.

Good luck with that!  Be careful what you ask for!

Everyone is importuning Merkel and Germany to save them.  Particularly annoying are the gratuitous proddings of Timmy! and Obama.  Timmy!’s post-bailout-that-wasn’t-a-bailout remarks were particularly grating.  Sayeth Timmy!: the bailout represents”concrete steps on the path to financial union, which is vital to the resilience of the euro area.”

Read that again.  Geithner, whom the (relatively) solvent Euros loath, is telling Europe that financial union is the way to go.  What chutzpah.

Germany realizes that such a financial marriage in haste will permit it plenty of time to repent its error at its leisure.  But there isn’t time to negotiate a solid pre-nup before the whole thing goes up the spout.  And I doubt there is a pre-nup that all parties are willing to sign, or would adhere to if they did.

The core of this game is empty, it seems to me. Which means that it is a matter of time before the whole thing collapses.  And that time is drawing nigh.

* Structural reform-supply-side measures, if you will-are essential to supporting long run growth.  But commentators insist on either misunderstanding this, or grossly mischaracterizing it.

For instance, consider the recent Roubini-Ferguson oped on Europe:

Structural reforms that boost productivity growth should be accelerated. And economic growth needs to be jump-started. The policies to achieve this include further monetary easing by the ECB, a weaker euro, some fiscal stimulus in the core, more bottleneck-reducing and supply-stimulating infrastructure spending in the periphery (preferably with some kind of “golden rule” for public investment), and wage increases above productivity in the core to boost income and consumption.

Uhm, none of those are structural measures.  They are all variants on Keynesian nostrums.

But that is nothing compared to the truly aggravating Martin Wolf:

Moreover, “structural reform” is a woolly term. If by this Mr Schuknecht means that falling prices, induced by ultra-high unemployment, debt deflation and sovereign and banking insolvencies, will ultimately restore competitiveness, he is correct, provided the country is able to stick with such policies, for a very long period indeed (probably a decade, or even far longer). This is what is required if a country with a large private sector debt overhang and a sizable structural current account deficit is to eliminate its fiscal deficit, regain competitiveness and restore growth, particularly in a currency union whose core country has a structural current account surplus and low inflation. The question is whether democratic politics (or the eurozone) will survive the experience. I doubt it.

Way to bash a straw man there, Marty! You know that’s not what German FinMin official Ludger Schuknecht meant by the term, and for you to insinuate otherwise is truly low.  Schuknecht is referring to the kinds of labor market and other reforms that transformed Germany from the sick man of Europe to the prosperous nation whose pocket everyone wants to tap.  If you want to discuss structural measures, at least do it fairly.  John Stuart Mill you ain’t. (Mill was/is legendary for his even-handed characterizations of his opponents’ views.)

With these clueless or deeply misleading analyses from esteemed purveyors of opinion, structural reforms don’t stand a chance.  Especially in delusional countries like France, which are hell-bent on implementing structural deforms.

After all that, isn’t a little musical entertainment in order? I think it is!

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5 Comments »

  1. Sorry Prof, but I’m not sure you’ve got the scenario right. Much of this is the, possibly fortuitous, coincidence of the journalistic interest in serving up a juicy headline and a sector of the investment community that sees an opportunity in exploiting misinformation.

    An alternate guess would have it that most of the debt, in the end, stays off balance sheet. The same EC circular that stated that it would affect to an unknown degree both the debt and deficit, makes it clear that equity investments can remain ‘off’. What go ‘on’ are funds that make up for prior operating losses. It is the distinction between ‘redistributive’ spending and that which can justified as potentially ‘market participating’ that determines this. There will be lots of arguments over the price at which Spain injects equity in this regard – but the rules are fairly clear.

    As for subordination, it’s likely that if any funds at all are forwarded under EFSF prior to July 1 that their pari passu character will be passed on to whatever is later granted under ESM. Thus the big rush to get the application in over the weekend.

    As for the commentators, you’re dead on. We all know that Roubini and his garbage barge have big skin in the headline game. But Wolf is in a league of his own. He was the one that decided that a brief survey of E-Bay was sufficient to come to the conclusion (very widely read a couple of years ago, having been published in the summer doldrums) that the cost of living in Spain was twice as high as in northern Europe. Just another hack – with the unfortunate attribute of having a reputation.

    Cheers

    Comment by CHB — June 22, 2012 @ 2:59 am

  2. Just a few factoids:

    - Has the Spanish bailout been done? I thought it was only an announcement. Between now and actual execution they still have a chance to do it right/better. The market reaction is indeed part of the dialogue and may help them understanding that.

    - Italian rates spiked ever so briefly and are back to approximately where they were before the announcement, go and read anything interesting in that.

    - The French change to the unemployment age is mostly symbolic: it applies only to people who started work at 18-19 and have been continuously employed until retirement (41 full years), that is, very few workers, mostly badly paid, with commensurately small pensions. You may find it’s sending the wrong message, but it’s certainly not going to cost or matter much given how few people it applies to.

    - The French employment system is two-tiers: there are “long term” contracts and “short term” contracts. Making it harder to fire on the former will just move more people onto the latter contracts, even if they spend decades for the same employer — the distinction is already not really on actual intended term any more, but on whether the employer is ready to keep the employee until they or the company dies. To some extent the safe contracts are bad for both employers and employees (who stay in crap suboptimal jobs for fear of never being back on another hard to get safe contract) so making them even safer means having more people on the flexible “short term” contract, which could actually be good overall.

    Comment by cig — June 22, 2012 @ 6:50 am

  3. What we are seeing in these establishment press rel – I mean profound analyses is pressure to keep the game going. Politically they paint the opposition to this ongoing tragedy as advocating starvation, terror, etc. this reduces policy discussions to the “are you still beating you wife?” level of discourse. Ironically, the longer the game goes on,the worse the adjustment will be – talk about self fulfilling prophecies! This policy of incremental-ism is really the fiscal equivalent of the death by 1000 cuts. At some point all hell will break loose: Wiemar inflation, political dislocation, whatever.

    Comment by sotos — June 22, 2012 @ 11:04 am

  4. There’s a lot of stuff going on over there right now in addition to the economic crisis:

    http://www.bloomberg.com/news/2012-06-22/ghost-of-nazi-past-haunts-austerity-gripped-europe-euro-credit.html

    Don’t think for a moment the euro elites — particularly those familiar with their not-so-distant past — aren’t waking up every day and going to bed every night looking for the first hint of another Kristallnacht.

    Europe’s fading on so many fronts. Christopher Caldwell had a particularly good review of “After the Fall: The End of the European Dream and the Decline of a Continent,” by By Walter Laqueur (Thomas Dunne Books, 2012)in The New Republic a couple of weeks ago, in which he noted:

    ‘Demographic decline fascinates Laqueur, who devoted much of his last book to it. He notes that, assuming no immigration, the United Nations projects Germany’s population to fall from 82 million to 61 million by mid-century, and Italy’s to fall from 57 million to 37 million. Even under the U.N.’s assumption of an uptick in the European birthrate, Europe is going to lose more than a hundred million people by then. By 2015 its working-age population will begin declining. Lord Grey warned at the start of World War I that the lamps were going out all over Europe. Laqueur has come to believe they were never re-lit. He grants that people have been prophesying decline for upward of a century, but he sees a difference: “Yesterday’s prophets were dealing with future trends, whereas those concerned with today’s Europe are dealing with developments that, for the most part, have already happened.”’

    As character is destiny, so too, for nations, is demography.

    The euro elites are trying to shore up institutions that either are crumbling or have been completely hollowed out. The financial system is bankrupt and its leaders are not to be trusted. Its state institutions — courts, government agencies, universities, etc. — are in a rearguard action to defend their continuance, lacking any agreement for their role, as the state itself cedes its raison d etat to some nebulous euro compact run from Brussels. This after centuries of euro elites selling out their respective populations and being more of an extractive uber-klass than disinterested leaders with a shared vision of the future shaped by well-fought — and shared — battles in the past.

    What happens when the economics are the least of these countries’ problems, and the real issues are existential? What happens when there’s nothing to believe in?

    Comment by markets.aurelius — June 23, 2012 @ 8:41 am

  5. From the Euro Area Summit Statement:

    ‘We urge the rapid conclusion of the Memorandum of Understanding attached to the financial support to Spain for recapitalisation of its banking sector. We reaffirm that the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status.’

    Where’s my SWP gold star? :)

    Comment by CHB — June 30, 2012 @ 2:38 am

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