Spanish bank bailout unlikely to succeed

It has been abundantly clear that Spain would need a bailout for its sick banking system, and rumours have emerged that this could happen as early as this weekend. I doubt that the details of a plan will be agreed so soon as an independent stress test of the Spanish banking system is still being carried out by Oliver Wyman/Berger (results due June 18th). Much more likely, EZ leaders will once again to plan to make a plan to make a plan to bail out the Spanish banking system. What are EZ policymakers trying to achieve with a Spanish bail bailout, and can they succeed?

With rumours about an imminent Spanish bank bailout at fever pitch, many have asked “why now?” EZ leaders will try to achieve three things with a bailout for Spanish banks.

First, there is a direct connection between Greece and Spain in terms of their banking sectors. We have witnessed a “bank jog” in Greece for months, which intensified in May. There were some reports of a bank run in Spain as well, though this is only true among foreign depositors in Spanish banks. A bailout for Spanish banks could be aimed at preventing a bank run from ripping across the periphery. EFSF/ESM money for Spanish banks is unlikely to succeed in avoiding a bank run, however. Depositors in the EZ periphery are withdrawing their money from banks over concerns about their countries leaving the EZ and their savings being redenominated and devalued away. A bailout for Spanish banks is very unlikely to allay these concerns.

Second, EZ leaders hope a bank bailout will reinstill confidence in the Spanish banking sector. Uncertainty about the size of the black hole in the Spanish banking system has been corrosive for investor confidence. Unfortunately, this too seems unlikely to succeed. There are currently two stress tests being conducted on Spanish banks, one by the IMF (published June 10th) and one by Oliver Wyman/Berger (published June 18th). The IMF stress tests have been completed and reportedly envision a €40bn bank recapitalization. This would make the Spanish bank bailouts cheaper than those for the Irish banking system (already upwards of €60bn), a veritable bargain! It is possible that EZ policymakers will wait to devise a figure for the bank bailout until Oliver Wyman/Berger publish the independent bank stress tests later this month. If the underlying assumptions in the independent stress tests involve years of recession and a further 20% fall in the property market as the base case, then they may be credible. There is a chance that, as with the independent stress tests done on Irish banks by Blackrock, the underlying assumptions for the stressed case actually become reality and further bank recapitalizations seem necessary.

Third, a bailout for Spanish banks would be aimed at avoiding one for the sovereign.  External capital flight from Spain over the past few months has made Spain’s external debt position even more sustainable. In the absence of capital inflows—unlikely as investors are not exactly flocking to Spain and the external economic environment means Spain’s export markets are not booming—Spain will need official financing to plug the gap. Furthermore, a bank bailout for Spain will most likely be funneled through the state (or through FROB) rather than being injected directly into banks. This means that the cost of bank bailouts will be foisted onto the sovereign’s balance sheet, making Spain’s public debt position look more unsustainable.

Even if a bailout for Spanish banks does not come this weekend, it will come soon. Unfortunately, it is very unlikely to succeed in drawing a line under concerns about Spain’s solvency. In the absence of economic growth, a bailout for Spain’s banks will be followed by a bailout for the sovereign as well.

For more in-depth analysis on Spain, its debt sustainability and its path forward, see Roubini Global Economics’ Spain Scenarios: Bring on the Bailout.

18 Responses to Spanish bank bailout unlikely to succeed

  1. Hello Megan , I’m a fan of yours here in Italy! I agree with you, but I don’t understand what you suggest for a solution? what would we have to see to have faith in Eurozone survival? I know it is growth, but how do you achieve that now? the private sector is deleveraging, and the corrupt public sector has wasted for years, now they can no longer spend.

    • Megan Greene says:

      Growth would certainly be a game changer in the EZ crisis, but it isn’t the only possible solution. A fiscal union would also do the trick. This could come in the form of fiscal transfers from the core to the periphery. It could also come in the form of Eurobonds. One form of a fiscal union through the back door would be a banking union. The likelihood of an agreement on any of these forms of fiscal union is best summed up in a venn diagram by @pawelmorski: In short, none of these is acceptable to Germany, particularly not in the time frame necessary to keep countries from peeling out of the EZ.

      • Denbo says:

        When you say Eurobonds are “not acceptable to Germany” it isn’t just Merkel, right? As I understand it the German Supreme Court shot down the idea of Eurobonds last year. I think it was because it went against article 125 of the Lisbon treaty which pertains to nations not being responsible for the debt of other nations.

        For the treaty to be changed there would need to be unanimous agreement. I don’t think Germany is the only nation against Eurobonds. I think PM Rutte of the Netherlands said he would not agree to them either.

        I am sure Megan can correct me on any of this. I am no economist I am just a software developer following this from afar.

  2. Spinoza500 says:

    This will fundamentally be a bailout of Spanish banks by German taxpayers and is a momentous move. Having blinked, German taxpayers will find that they have to provide the same for banks in Ireland and Portugal plus probably a second round in Spain as the true problem becomes clear. Perhaps Italian banks as well ? The Greeks will also win major concessions as long as they elect an assertive government. Merkel has still to explain the reality of European monetary union to the German people but she does seem prepared to get out the German cheque book just in time and to accept the severe implications for Germany. This is excellent news as long as the German people will accept the burden.

  3. Pingback: Spanish Bank Bailout Unlikely to Succeed « InvestmentWatch

  4. Hi Megan, also a fan.

    I think perhaps it is Germany that must leave the Euro in order to save the Euro. And to prevent the periphery from having to return to currencies (or create new ones) that will instantly devalue massively and force additional peripheral countries out of the Union. Maybe better to let Euro become a weaker, though still functional, currency for many nations while Germany goes with a stronger currency. Lots of implications, isn’t easy, but still preferable?

    To create and integrate a fiscal union will take considerable time to be approved by the many countries who have understandably been hesitant to relinquish sovereign control of their own central banks and governing bodies to Brussels or anywhere else.
    Germany could signal its intent to rejoin the Euro currency upon a formalized fiscal union and banking system. Once the unsustainably debt burdened nations have improved their ability to align revenues and expenses – whether through increased tax burdens, more competitive wages and goods, or debt repudiation/default/restructuring – likely a combination, then German re-entry to the EZ might include Eurobonds and other mechanisms that Germany has refused to allow to this point.

    This would still be very disruptive and disliked, even by Germans, who worry their exports will drop. However, their exports are falling anyway under the recession already underway. No seriously actionable program has really been established to expunge the debt saturation of the periphery.The European Union currently operates with a multitude of currencies, and still affords cross border movements of people, capital, goods, and trade benefits. The monetary union, the EZ, shares a common currency but is hindered by not having a fiscal union or a banking union (with Euro wide deposit insurance).

    Most pundits expect Greece will chose to leave or be forced out of the Euro as the currency its debt is denominated in. Spain’s banks will still need to be recapitalized at a level the sovereign state cannot afford. Italy’s sovereign debt appears headed for interest rate levels that can’t be serviced as rollovers mount. Portugal and Ireland’s situations are not improving. The intertwined banks loaded with leveraged purchases of sovereign bonds that have fallen in value remain an ongoing problem. Germany’s departure from the Euro may be less harmful than the trajectory the EZ is currently hurtling along.

  5. Why is it so crucial to protect EZ banks? If they are insolvent then shut them down and freeze all assets. Deposits up to a certain threshold could be guaranteed by a European version of the US FDIC (Federal Deposit Insurance Corporation). Monies paid out could be recovered from banks over several years via a Euro FDIC levy. The current situation is creating zombie banks, the worst of all worlds. Let them fail and in no time the phoenix will rise from the ashes.

  6. Jay says:

    Blackrock’s “stress test” of Irish banks was fatally flawed. They assumed in their mortgage default assumptions a repossession period for properties “similar to the UK” due to the lack of data on repossessions in Ireland.

    “Given the lack of re-possession data in Ireland, BlackRock assumed that Irish repossession levels would converge with those in the UK.”

    The fact of the matter is properties can take YEARS to be repossessed in Ireland and more importantly, repossessions are extremely rare due to their politically unpopular nature. In the UK, the process is very efficient and quick. So these properties will be sitting on bank balance sheets accruing unpaid interest for years, adding to unrealised losses. Loss severities are likely to be massively understated on Irish property. There is also the fact that the Irish property market is so disjointed that you have no bid for many properties so assuming a flat market value decline for all properties is likely to understate loss severities

    I would be highly dubious of the forthcoming Spanish stress tests. Does anyone really believe the Spanish government is not going to review the report first and exert pressure for the testers to come up with a number that is far less scary to the public than what reality reflects. I’ve done stress testing, valuations and the like for large institutions, and often when they don’t like the result there is a tug of war on “changing assumptions” to get the answer they want, from changing discount rates, to default rates, arrears levels etc.

    These stress tests are nothing but a dog and pony show for public consumption.

    Remember those stress tests of European banks? Remember how high they rated many banks, many of the same banks in serious trouble.

  7. Avi says:

    Europe is fragmented and not a uniform body plagued by different mentalities, religions, languages, there are more traits setting them apart than with unification, the only solution is to dismantle the EU and return to each owns currency and economy, the EU is doomed to fail.

  8. UKsaver says:

    Hello Megan, could you please investigate what is happening at Santander UK? This is supposedly an ‘independent’ bank covered by UK FSCS scheme. I have anecdotal evidence (directly from Nationwide e’ees) that Santander UK customers are transferring their sterling savings (ISAs and such) from Santander UK to Nationwide. I’m sure to other UK banks too. i.e. There may also be a ‘stealth’ run/jog/walk on the UK business. People read the headlines and after Northern Rock will behave ‘rationally’ even if different jurisdiction. Santander UK after all scooped up savers from other failed UK banks, so we’ve been here before. Thanks.

  9. $125B is a big bazooka but will it succeed in restoring confidence or turn the attention of the market towards Italy? Caio.

  10. Pingback: Spain's Euro Bailout Might Boost Markets Tomorrow But Don't be Fooled - Forbes

  11. Pingback: Spain’s Euro Bailout Might Boost Markets Tomorrow But Don’t be Fooled | :

  12. Pingback: Spain’s $125 Billion Euro Bailout Will Not Be Enough

  13. Pingback: The bailout of Spain’s banks shows the heart of our problem « Fabius Maximus

  14. Pingback: Economic Insanity: Italy bailing out Spain?

  15. Pingback: 19th June 2012: So Where Are These Spanish Banking Stress-Tests? « Market Nightshift

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