Spain is running down the same path Ireland did. The path leads to national insolvency, over-indebtedness, bailed out zombie banks that won’t lend, and a concomitant loss of sovereignty. Spain’s problems begin and end with its banks, like ours did. But there are important differences between Ireland and Spain, as we shall see.
But first, we need to dispel some myths. If the Spanish bank bailout is, in real terms, the same as the bailout Ireland’s banks received, then the rivers of ink spilled in anger about the differences between our own situation and the situation in Spanish will have been for nothing.
The way to understand any economic situation is to stress test the situation with an extreme scenario. So, just imagine this scenario: Spain's banks suffer huge losses, on an Anglo-Irish scale, say of around 50%, on the property portions of their portfolios. It gradually becomes clear that very little of the 100 billion euros lent to those banks will be coming back to the European authorities.
In this scenario the Spanish taxpayer is on the hook for the shortfall, and no one else. In Spain there is no explicit guarantee of the assets and liabilities of every bank, in the same way Ireland did in 2008, but the implicit guarantee of the Spanish banks by the Spanish sovereign is there.
With this caveat in mind, in a sense the Spanish bailout is exactly the same as the Irish one: the taxpayer is on the hook for any and all eventual losses on the 100 billion euro loan.
It is not an accounting mirage, by any means, but an almost direct recapitalization of Spain’s banks by the European authorities. The recapitalisation was supposed to have a calming effect on the markets and allow the Spanish government to borrow on its own. This plan hasn’t worked in the slightest, and the markets are getting rid of as much Spanish debt as they can right now.
Ok then. What are the similarities? Before 2007, Spain had consistently good public finance figures. However, these healthy fiscal results during the boom times helped mask large problems in the real economy. Sound familiar?
Spain, via its banks, allowed its public finances to become reliant on an externally financed property bubble that also saw the country’s banks over-extend themselves as its construction sector grow unsustainably large. As in Ireland’s case, when the boom inevitably turned to bust, it blew a hole in Spanish government revenues.
So: like Ireland, Spain went from best in class to basket case in five years or less. This past weekend we’ve learned that Spain’s banks may need up to 100 billion euros in aid from several European bailout funds, channeled through a NAMA-like intermediary that will recapitalize the banks and heal their balance sheets temporarily.
The move has not been well received by the markets, which began selling off Spanish government debt the moment the markets opened on Monday. The plan was supposed to buy time, as Ireland’s successive and ever-increasing bank rescues were. Our rescues in total have so far cost us around 43pc of our national output, roughly 64 billion euros. Spain’s 100 billion euro cost of rescuing their banks is around 9 pc of its national output, and will grow.
But here all clarity breaks down.
It’s important to clear up a few points, to reduce the noise a little bit. First, Ireland guaranteed the assets and liabilities of most of its banking system using the credibility of the Irish State. The Spanish authorities have wisely avoided this move. The only guarantee Spain’s banks have is the implicit backing of their sovereign. Before last weekend, Spain has actually already made almost 120 billion euros worth of provisions for their banks. So the implicit guarantee is there, and this is also backed up by a European Directive (Directive 94/19/EC) that guarantees deposits in banks up to a limited amount in each country. So Spain’s depositors have the backing, to a certain extent, of the European Union.
Second, Spain is not receiving a loan package the way we in Ireland did in November 2010: there is no Troika for Spain’s leaders to deal with. The conditions attached to Spain’s loans only affect Spain’s banks, not the Spanish government’s spending and taxation plans. Spain has already agreed to implement austerity policies, it has ratified the Fiscal Compact, and so there is not much point in asking more of the Spanish authorities. So in this sense, the Spanish loans are just for Spain’s banks.
Spain is footing the bill for their banks in the end however—the loans are coming from the European bail out funds, but are being added to the Spanish national debt. Spain, once the best in class, is now en route to basket case.
And so, despite these differences between their loan packages and ours, the end result may be the same: a loss of national sovereignty and a series of damaged banks unable to lend into the real economy. As I mentioned above, market concerns centre on the implicit guarantee the sovereign has over its national banks. The worry will be whether concerted efforts aimed at backstopping the banking sector by throwing billions into the balance sheets of these banks are too much to handle for the Spanish sovereign, pushing Spain into a fully-fledged Troika-like programme of adjustment despite the efforts of the Spanish authorities and the Europe’s leader.
What is needed is a mechanism to separate the fiscal and banking problems Spain has but decoupling the sovereign debts from the private bank debts. This requires a different strategy to the one Angela Merkel and Co. are pursuing, which is to treat each country’s banks as the problem of that individual country, and assist as necessary with bailout funds charged at low interest.
The correct, and horribly expensive, option is a European banking resolution system--- French for a banking union—is the only effective way to separate out the banking debt from the sovereign debt. Remember that without the debt run up saving our wayward banks, Ireland’s national debt today would be lower than Germany’s at around 80 pc instead of 108pc. Then Spain could borrow from the private markets without fear, and the contagion risk would abate. This is all fine and good, but with this many damaged banks across Europe, such a plan amounts to asking the German and French people to hand over their credit cards to their neighbours. And which of you would do that without assurances?
Writing in this newspaper on May 15th, I argued our future in Ireland now hinges on Spain's reaction to their fiscal and banking crises. Ireland is planning to re-enter the bond markets to borrow to keep the State going in 2013 and 2014. If Spain’s difficulties are not resolved, then the bond markets could be wary of any peripheral State, and so Ireland, despite all its hard work, may end up needing extra funds from our friends in the Troika.
So, when it is clear that Spain looks like it is heading down the same path that bankrupted Ireland, I can say that this is not good for us, at all.
Published in the Irish Independent, June 13.