It’s a bailout but not as we know them

Conventional wisdom would dictate it’s troubles are an after shock of the financial crisis and the contagion jump from Sub prime and Lehmans. Closer scrutiny would suggest a different cause and effect where the freeze in wholesale debt markets revealed fault lines in Spain, which were already deep and long established.

Why is Spain in so much financial trouble?

Conventional wisdom would dictate it’s troubles are an after shock of the financial crisis and the contagion jump from Sub prime and Lehmans. Closer scrutiny would suggest a different cause and effect where the freeze in wholesale debt markets revealed fault lines in Spain, which were already deep and long established.

Spain has in its stable great brands such as Repsol, Zara, and IE Business School, one of the best in Europe. It has a reasonably diversified economy and a level of national debt, which was by no means the worst in the Eurozone pre crisis.

So why does it need a recapitalisation of its banks?

The root of the problem is debt taken on by the private sector to fund speculative development activity. In the past Spain like a number of Mediterranean countries paid higher rates for its debt than stronger more competitive economies like Germany and Britain.

The advent of the Euro and low interest rates provided a ready source of cheap money and tempted many regional governments to borrow heavily as they competed to develop local airports, culture centres and retirement homes intended for rich North Europeans. As wholesale funding from foreign banks began to dry up, rollover of debt became increasingly difficult leaving many projects half completed. Some finished airports such as Castellon in Valencia haven’t seen a single passenger flight, despite an investment of150m Euros.

Alcoron, a town near Madrid owes over €600m much of which has arisen due to an unfinished culture and arts centre.

Collectively regional governments owe billions on top of the national government debt pile.

In the whole of Spain it is estimated that 2 million half built homes are now unable to be completed.

The offer of an injection of capital from stronger nations may well stabilise the situation for now but until the losses are realised; (unpalatable), or growth resumes; (unlikely), this could just be another case of expending significant dry powder to kick the can down the road, leaving the EU denuded of funds which may yet be needed.

The challenge is preventing banks failing and taking depositor funds down with them, as well as some regional governments, who are also significantly indebted, and dependent to a large degree on the struggling regional banking sector.

Lets hope an EU wide depositor compensation scheme, bank resolution plans, and stability mechanisms can be built which allow banks to fail and speculators to absorb their own losses, without being bailed out at taxpayers expense, or at the expense of saver’s who have done the right thing.

Meanwhile world stockmarkets are rising this morning as the sugar rush effect of another quick fix gives a boost to confidence. With the Greek elections next week and left of centre anti austerity parties gaining ground in the French parliamentary elections the rallies may be short lived.

What it may mean in the long term is the slowdown is extended because the short term pain hasn’t been taken and losses sitting on balance sheets, which should be written off, are being carried, with the problem simply deferred.

Everything will depend on the terms of the bailout, because in reality that is what it is. If political union follows and the debts are underwritten by Germany and absorbed, then recovery make take hold. If not we will creep and stumble to the inevitable day of reckoning.

I guess if I were sitting in Greece, Ireland or Portugal I should be pretty fed up just now, given the extent of the strings attached to their Sovereign bailout arrangements, which are absent from the Spanish deal.

Clearly Spain’s leverage is so powerful they got a better deal, driven by collective fear of a Spanish Sovereign default triggering a collapse of the Eurozone.

Italy next?

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