Nouriel Roubini's Global EconoMonitor

Get Ready for the Spanish Bailout

From the Financial Times:

No one can pretend to know whether Spain is illiquid or insolvent without gauging the size of the black hole that is the country’s banking sector. The Spanish government is finally starting to do this: Bankia and other banks are reportedly set to receive a capital injection from Madrid. With the Spanish economy contracting sharply and with unemployment soaring, it was inevitable that the government had to bail out the banks. But this only deals with one piece of the puzzle. Without growth, the Spanish sovereign will need a bailout as well.

Spain’s credit boom peaked in 2008 when the supply of cheap, external finance began to fall sharply. Four years later, Spanish banks’ asset quality continues to plummet. The sector will require €100-250bn in recapitalisation later this year to maintain a 9 per cent core tier one capital ratio, the minimum stipulated by the European Banking Authority. In the meantime, there are concerns about the capacity and appetite of Spanish banks to support the sovereign, particularly amid rating downgrades and deposit withdrawals.

Ideally, a bailout for Spanish banks should come immediately and in the form of direct capital injections from the EU bailout funds. Germany remains staunchly opposed to this, as it would mean giving up the stick of conditionality and feeding Spain the funding carrot. Such an option is also resisted by the Spanish authorities as the EU taxpayer will effectively take over their banks.

Instead it looks like a bailout for Spanish banks has been postponed until the very last minute. The cost of a bank bailout would then be foisted on to the Spanish sovereign’s balance sheet.

Bank bailouts on this scale may well bring the Spanish state to its knees. If they don’t, Spain’s public and external debt positions will.

In order to stabilise its public debt levels after a bank recapitalisation, Spain would have to generate a swing in its public finances that is not only unrealistic, but also self-defeating. The tax hikes and spending cuts required would make the recession deeper and cause the primary balance to deteriorate.

In order to put itself on a path towards external debt sustainability, Spain would need to see a huge adjustment in its trade balance. In the short-run, a fall in domestic demand could quickly improve the trade balance. However, in the medium-term, Spain can only service its foreign debt if it finds balanced and sustainable growth, which requires a real-terms depreciation that will not occur unless the value of the euro falls sharply.

Anyone who has closely followed developments in the eurozone will be struck by déjà vu looking at Spain’s current predicament. The corrosiveness of banking sector uncertainty for investor confidence in Spain is reminiscent of Ireland in 2009 and 2010. Spain’s austerity-recession feedback loop is similar to the process that fed the economic contraction in Greece and Portugal.

And yet despite the clear signs of failure in the existing bailout countries, the EU looks set to pursue an unchanged plan in Spain. But the crucial difference between Spain and the bailout countries is size. If things go wrong in Greece, Portugal and Ireland, a second bailout is affordable. But there can only be one roll of the dice for a country as large as Spain.

A bailout package would buy some time for Spain, but time will only help if it is used to generate economic growth. By making private claims on the sovereign junior to the claims of the troika (European Commission, European Central Bank and International Monetary Fund) even a bailout risks reducing the chances of it regaining market access. Moreover, with economic indicators showing Spain sinking further into recession, a turnround in the country’s economic performance would require a significant shift in policy: monetary easing by the ECB, a weaker euro, fiscal stimulus in the core, less front-loaded austerity in the periphery, more international firewalls and debt mutualisation.

The only way for there to be a happy ending in Spain is if action is taken swiftly in Brussels, Frankfurt and other European capitals. But that is not likely to happen. The eurozone periphery and Spanish crisis look like a slow motion train wreck.

The writer is chairman of Roubini Global Economics and a professor at the Stern School of Business, New York University. He co-authored this piece with Megan Greene, director of European economics, Roubini Global Economics.

33 Responses to “Get Ready for the Spanish Bailout”

Valli GenevieveMay 9th, 2012 at 8:45 pm

Iceland seems to have taken another route and come out on the other side. Is there any reason that Spain cannot allow the banks to fail rather than ask the Spanish people to take on a massive amount of bank debt which will require ongoing austerity in a never ending loop?

What am I missing that Iceland is not discussed as one possible way forward?

KimMay 30th, 2012 at 6:56 pm

The issue is not abandoning the euro, but letting insolvent banks fail. Spain would be reprehensible for covering amounts covered by deposit insurance (and receive an equivalent claim on the failed banks), but a portion the large deposits (domestic and international) would be converted to equity (sufficient to recapitalize) and the remainder to a longer term bond. This is costly, but it does no put the government on hook for large depositors who did not do their homework.

Olafur MargeirssonMay 10th, 2012 at 3:35 pm

First, we (I'm Icelandic) didn't "allow" the banks to go under; the then-government and the central bank tried everything to keep them afloat (liquidity provision, both in ISK and EUR, that we never got back and in fact bankrupted the Central Bank) but there wasn't money around to bail the banks out. After all, they were 10 times the size of the GDP (this isn't a typo).

Second, the payment system in Iceland is different and the main reason for why we were capable of reconstructing the banks on their ashes and keep commerce going. Spain cannot do this, I believe, due to the organisation of the payment system.

Third, we set up capital controls that stopped funds amounting to roughly 60% of GDP from flowing out of the economy. Obviously, the krona (our currency) would have plummeted even more than it did otherwise. I don't know exactly the difference between EU and European Economic Area (we're in it, but not the EU) rules regarding free flow of capital but Spain may have more difficulties setting up capital controls than we did.

Fourth, those funds are still locked in and the problem is just growing since those funds gather interests by the day. Iceland isn't out of the woods yet, check out the link for a further clarification why.

All the best!

Valli GenevieveMay 12th, 2012 at 10:04 pm

Dear Olafur, thanks so much for your thoughtful reply. i knew I was missing something big and of course, I forgot that Iceland had their own currency and thus had many more options.

SpaniardMay 22nd, 2012 at 10:48 am

Iceland is small, Spain is big. If Spain does what Iceland did, all the european banks would collapse in a second. That's why.

Jan PolonieckiMay 9th, 2012 at 10:24 pm

Yes, why not let Bankia and some but of course not all banks fail? My question is probably dumber. How could a bank fail that could borrow 100s of billions from ECB at 1% and put them in Spanish sovereign bonds at a margin of about 5%?

Jennifer KapilaMay 10th, 2012 at 8:48 am

1) Ireland redux, these banks don't have much unsecured debt to "bail in"

2) Funding flight and depletion of eligible collateral

diatoo1May 12th, 2012 at 9:25 am

Because the 4 billion they gain in interest each year are peanuts compared to their funding requirements.

BandraboyMay 16th, 2012 at 1:29 am

Because it was invested in Spanish government debt which then fell in price so the ECB required ever more capital lodged and this caused the price of spanish govt bonds to fall so the ECB required ever more capital lodged and on and on.

Manuel RoldánMay 9th, 2012 at 11:20 pm

Spain to play with the size of its debt in its favor. They can break the Euro with its failure. The internal deflation does not work in any country. Only the default and the recovery of monetary sovereignty may work at this point. So Iceland grows, so sink the PIGS.
The point is that the crisis is just an excuse to destroy the welfare state and labor rights in the peripheral countries of the European bloc, so that the core can address a scenario where the price of energy advice deglobalization of the economy.

Angry SpaniardMay 10th, 2012 at 12:07 am

Greetings from Spain.

The problem with Bankia and other local savings banks is they have been wasting lots of money in expensive political projects and now they are ruined.

To Nouriel Roubini & Megan Greene:

Brilliant analysis.

There is only one problem: if you expect people and Government in Spain taking the right (but painful) decisions, you should wait for Santa Claus near the chimney.

To Valli Genevieve:

"Is there any reason that Spain cannot allow the banks to fail rather than ask the Spanish people to take on a massive amount of bank debt which will require ongoing austerity in a never ending loop?"

The Government of Spain is not going to allow the banks to fail because they don't realize (or don't want to know) that we are so broken as Greece, and people agree with this way of thinking. It's easy being like the Monkeys of Nikko.

To Jan Poloniecki:

"My question is probably dumber. How could a bank fail that could borrow 100s of billions from ECB at 1% and put them in Spanish sovereign bonds at a margin of about 5%?"

If the bank invests that profit in loans to local governments, labor unions and political friends with no economic criteria (as required to private investors) is sure as the sky is blue that the bank is digging its own grave.

To Manuel Roldán:

"The point is that the crisis is just an excuse to destroy the welfare state and labor rights in the peripheral countries of the European bloc".

We, the Spanish, and only we are responsible of taking debts that we can't afford.

BobitoMay 10th, 2012 at 8:55 am

We, who live in Spain (we are not all Spanish), are not responsible for taking on debts that couldn't be paid. That responsibility lies with an inept government, inept businessmen, and inept bankers.

IndignadoMay 10th, 2012 at 4:17 pm

'We, the Spanish are responsible for taking debts that we can't afford?' I haven't taken any debts, nor aproved with my vote on elections any of the political parties responsible for it. I have religously paid my taxes and saved money for bad times, I'm on rent and the only crazy thing I've done is having a baby 6 months ago. Now I have to pay for the mistakes and abuse of others. And you hold me responsible for this mess while the welfare state I've paid for is dismantled??? With all due respect Sir, speak for yourself!

Mr. BlondeMay 10th, 2012 at 3:14 pm

We, who live in Spain, obviously are responsible for taking debts that we won't be able to pay!! That's called irresposible behaviour…and for too long many people who live in Spain had got used to an easy life where we were not responsible of anything!!And that it's problably one of the primary causes of the situation. It's too late to hide behind "I didn't know" "I thought that".We claim to be free and as free people we must understand freedom as the biggest responsability. Some made profit of us but we let them to do it!. However an inept goverment is therefore elected by inept people, and inept banks usually loan and mortgage to inept people!.
There is no such a thing as Conspiracy theory in order to end the welfare state and labour rights…those are consequence of many factors, among we can find a dreadful Administration and management, also important is the wrong belief our high growth was sustainable and endless…There is no such a thing as eternal economic growth, resources are limited. Sadly the only solution as very well pointed out in the article comes from brussels and above all from Germany and it is quite improbable! And problably in a long term view Germany and other will regret but not recognise their current mistakes!

BobitoMay 16th, 2012 at 2:43 pm

What a bunch of nonsense. I am a permanent resident in Spain. Though I pay taxes, I have no vote in this supposedly democratic country (as I would not in any other supposedly democratic country). How can I stop banks from doing what banks do? I am not a violent man, and I do not want to see the place I live torn by violent revolution – so how do you propose that the situation be changed? My personal accounts are in good order, although the banks I have them in have an unfortunate tendency to collapse or be taken over by the government (also in the US). I don't have much choice – all the retail banks are pretty much the same – some with higher fees – and I don't feel safe putting my savings in the wall of my house.

HepionMay 21st, 2012 at 11:41 am

Actually, you spaniards are caught in a bold new currency experiment that just does not work.

It is called the euro.

Gold standard failed, bretton woods failed, now the euro, world is not ruled by wisdom.

Pedro BatistaMay 10th, 2012 at 6:05 pm

That's right ! We are now getting to that point that i have defend in past : It is time to Germany say if they want a euro or not, bank or leave it.

WojMay 10th, 2012 at 6:17 pm

"But there can only be one roll of the dice for a country as large as Spain."

Paul Martin, the Former Prime Minister of Canada, spoke at the recent INET conference in Berlin about the importance of governments getting policy right the first time. More specifically, he was discussing policies related to stimulus or bailouts. From his perspective the first attempt must provide enough firepower to resolve the situation, otherwise support for future attempts will dwindle along with the potential to vastly increase resources.

In the case of Europe, Greece needed multiple bailouts before actually defaulting and yet remains likely to need further bailouts or risk another default. Portugal may very well need a second bailout later this year. Given these missteps, support for a substantial bailout of Spain is already going to be a difficult sell. It’s hard to envision the EU/ECB/IMF garnering enough firepower in the first go around to recapitalize the Spanish banking system and stabilize public debt concerns.

barfMay 11th, 2012 at 1:34 am

the State does not know sophistication only control. they will demand ownership…they will nationalize. Spain first…then Greece…then France. And it will happen "just like that."

economic fractalistMay 13th, 2012 at 7:25 pm

Spain will be last Troika tranche.

It will be done because it must be done, and currently, can be done. The banking community doesn't have a choice, like a bad husband who has lost 90 % of the family weekly paycheck in a gambling game gone wrong and must face his wife and five children the next day … deciding to risk the final 10 % on the improbable chance of partial recovery….

Based on the patterned science of asset-money-debt saturation macroeconomics, this will be the last of the Troika's money on the table.

David RicoMay 16th, 2012 at 5:22 pm

Obviously the internal devaluations are not working or they take years until their effects will be visible (trade deficit). Spain only alternative is to find a way of growth, not just for this year, but for the long term (I believe this is what investors are really fearing). And after all the reforms (with minimal or neglegible impact) of the government they had not come up with an Economic Plan for Spain for the next 10 years. The ECB monetary easing, even the real devaluation of the Euro, and the EU stimulus packages will be useless unless a radical growth plan is presented.

Deepak SinghJune 1st, 2012 at 9:54 am

A depressing scene indeed . Would this result in the death of Globalization. Do we see the
" World is Flat ' changing to " World becomes Round Again " . Would this not be a necessary
precondition for the effected Countries to retain at least a semblance of their standards of Living.

MartinJune 1st, 2012 at 10:19 pm

It is time that the financial industry is adjusted to its right size…rightsizing. It happens with every industry that overshoots its capacity. Too many years of funny money.

mariaJune 6th, 2012 at 9:26 am

Too many years of tax holiday for the richests, too many years of destroying manufacturing capacity in Europe and USA and moving it to countries where there is no wealth redistribution, too many years of easy money to mantain consume levels and support delocalization creating a huge manufacturing over capacity and huge debt levels at private, finance and state levels. And now, the world is stalled and bankrupt. The rich are richest than ever, but as there is no wealth redistribution and there is excess capacity the world is hard landing soon.