The Spanish bail-out
Going to extra time
The €100 billion pledged to help Spain was meant to rescue the banks and calm the euro zone. Instead it has added to the drama
IT WAS a victory for the euro. It was a credit line. It was “the thing that happened yesterday”. The one way Spanish prime minister Mariano Rajoy refused to describe the pledge of €100 billion ($125 billion) from other euro-zone countries to recapitalise Spain's banks was as a “bail-out”. Nor was it a rescue, the economy minister, Luis de Guindos, insisted; just “a loan with very favourable conditions”.
Regardless of the conditions, the outcome was less than favourable. The package had been put together during a series of rushed videoconferences of euro-zone finance ministers on June 9th. The European Commission president, José Manuel Barroso, says he pushed Mr Rajoy, who had previously denied the need for any deal, into accepting one. Mr Rajoy has claimed it was he who did the forcing, insisting on a deal focused only on the banks. What is certain is that a need to calm markets before the Greek election on June 17th piled on the pressure.
The markets were not calmed. By June 12th bond yields were higher than they have been since the country adopted the euro in 1999; if they stay that high for long the kingdom of Spain itself would need a bail-out (see chart 1). Even without government circumlocution, enough was fuzzy about the deal to have investors worried. Yet some things were clear: while Spain now has a plausible plan to recapitalise its banks, the new money does little to resolve the Spanish economy's other fundamental problems.
Not like the others
Mr Rajoy's unwillingness to talk of bail-outs stems from a desire not to have Spain spoken of in the same breath as Greece, Ireland and Portugal (see chart 2). To reassure Spaniards that things were different he insisted that the money came with no strings in terms of new, more austere government policies, just some conditions for the banks. The euro zone's “men in black”, as the budget minister, Cristóbal Montoro, calls them, would not be visiting.
But on June 11th Germany's finance minister, Wolfgang Schäuble, insisted that the troika of lenders—the European Commission, the IMF and the European Central Bank—which administers the bail-outs of Greece, Ireland and Portugal would be heavily involved in Spain too. Euro-zone ministers said Spanish policy, which they endorse, would be scrutinised and “regularly reviewed”.
One basis for Spanish exceptionalism is that Spain can be seen as too big to fail. “There is not enough money to rescue both Spain and Italy,” says one government official. That allows it to dig in its feet. According to El Mundo, a newspaper, Mr Rajoy reminded Mr de Guindos of this by text during the negotiations: “Spain is not Uganda. We are the fourth-largest economy in the euro zone.” Officials refused to comment on this claim; wags on Twitter were quick to point out that Uganda's GDP growth and unemployment rate are both far better than Spain's, which is set to see GDP decline by 1.7% this year and suffers 24% unemployment.
The other basis for exceptionalism is that Spain's crisis is not like those of Greece and Portugal; to begin with, at least, it really was all about the banks. When the global financial crisis hit in 2008, Madrid was relatively calm. Spain's banks were hit, but they had not invested in the toxic off-balance-sheet products that sank banks elsewhere. The then prime minister, José Luis Rodríguez Zapatero, boasted that Spain had “perhaps the most solid financial system in the world.”
But though Spain's banks had, as regulators required, made thrifty counter-cyclical provisions, they were also parties to an ungodly property bubble (see chart 3). Property prices tripled between 1995 and 2007. Construction and real-estate loans grew from 10% of GDP in 1992 to 43% in 2009, according to a new IMF report.
A great deal of the lending was by Spain's unlisted regional savings banks, or cajas. Their share of the financial system, measured in terms of assets, rose from about 10% in the 1960s to nearly half by 2010, increasingly lending outside their region of origin. Fierce competition led to ever more bank branches opening; Spain ended up with one for every 1,000 people, making it one of the most overbanked countries in the world.
The world's most solid financial system
After the property bubble popped in 2008, banks began acquiring properties from developers before the loans that supported them went sour. As the economy entered recession, foreclosures mounted. Spain's banks may now own a fifth of the total stock of empty homes, according to some analysts' estimates.
The reluctance to cut losses has delayed the adjustment in house prices, which have fallen by 25% from the 2007-08 peak, according to various indices. Irish prices, in comparison, have dropped by roughly half. Even though Irish prices rose more in the boom, Morgan Stanley, a bank, reckons that 50% could be on the cards for Spain, too, with the bulk of the remaining correction this year and the next. Supply and demand cannot be matched because the banks own so much property, says Jesús Encinar, founder of Idealista.com, a real-estate portal (see article). “Banks are only giving mortgages on their own apartments. They will give you a 100% mortgage [but only] if you buy one of their flats.”
Mr Zapatero had several opportunities to clean up the banking system when government financing costs were lower, but dragged his feet. Spain created its bank bail-out fund, the FROB, in 2009, with a potential capacity of €99 billion; by 2012 it had dispensed only €14 billion. An industry-backed deposit-guarantee fund has provided another €13 billion.
A key obstacle was that the cajas didn't have shareholders; they were controlled by a mixture of politicians and depositors. Many cajas were operated by regional barons as development banks that could further their political purposes, says Luis Garicano of the London School of Economics. The cajas boasted that they had survived 200 years. Some, such as those in the Basque country, did indeed look healthier than commercial rivals. But the failure of governance at others was of epic proportions. Isabel Cambronero, a professional dancer appointed to the control committee of Caja de Ahorros del Mediterraneo, bailed out and later auctioned, said nobody ever told her there was a crisis. Other ex-board-members tell of meetings in New Delhi and Chicago. Huge pay packages and golden handshakes were the norm.
The cajas of old are now more or less gone. The advent of FROB and a rise in capital requirements forced the country's 45 savings banks into a frenzy of consolidation. There are now just 11, all set up on modern lines. But these mergers were often fudges that simply compounded the problem. The caja ownership model made it hard to raise capital, and the reordered system reflected that lack. Last summer Bankia, a merger of seven savings banks, and Banca Civica undertook tortured stockmarket listings. A larger rival gobbled up Banca Civica at a discount; Bankia was bailed out on May 26th, its troubles calling into question assumptions about non-performing loans elsewhere in the system and spooking the markets even more.
The €100 billion loan from the euro zone should head off the sort of panic that might lead to bank runs while enabling the banks to purge their balance sheets of dud loans. But it is doing so by piling even more debt on Spain's weary shoulders. Channelled through the FROB, the loan will count as sovereign debt, potentially adding nearly 10% of GDP to Spain's debt burden this year. At 90% of GDP that burden would still be less than in other highly indebted countries in the euro zone. But markets were also rattled by the possibility that the new loans might take priority over private creditors. The money seems likely to come from the new European Stability Mechanism (ESM), which will be a preferred creditor; that would make Spanish bonds a bit more risky for other creditors.
The loop of doom
What is more, the bail-out does not break the feedback loop through which Spain and its banks are making things ever worse for each other. With foreign investors heading for the hills, Spanish banks have stepped in to buy even more government bonds, with the help of the ECB's cheap three-year loan programme. The more foreign investors leave the market—as they seem to have done this week—the less sustainable this becomes.
The men in black might help with this. Spanish lenders taking bail-out money will be subject to European Union (EU) state-aid rules. Many will be forced to clean up boards and sell stakes in large industrial companies (a welcome development). Mindful of this, some banks were quick to say they did not need the cash. But the IMF report says that only the three largest Spanish banks—BBVA, CaixaBank and Santander, which account for 47% of assets—appear able to cope on their own if things get bad.
Part of the troika's brief will be what the euro-zone governments call, opaquely, “horizontal structural reforms”. Judging by the IMF report these might include disentangling the Bank of Spain's regulatory powers from the economy ministry's and strengthening them. The IMF also called for the introduction of a bank-resolution scheme that would impose losses on both shareholders and bondholders. And Joaquín Almunia, the EU's competition commissioner, has said that Spain may need to liquidate one of its bailed-out banks.
Unlike the governments which oversaw bail-outs in Greece, Ireland and Portugal, all of which were booted out soon thereafter, Mr Rajoy is not in serious political danger. He has an absolute majority in the Cortes, and is only six months into a four-year term. Most of the country still blames Mr Zapatero for the mess. But Mr Rajoy risks increasing Spaniards' alienation. His People's Party has blocked an investigation of Bankia, which was run by managers the party appointed. He looks unlikely to appear in parliament to explain the bail-out until mid-July. And he seems allergic to journalists and their pesky questions. On a recent Senate visit he sneaked out of the back door to avoid them.
There is a growing feeling, says Josep Lobera of Metroscopia, a polling company, that Mr Rajoy has no real plan for Spain's economy and merely reacts to events by improvising. Spinning “the thing that happened yesterday” as a famous victory will only increase that. And the public's faith in Europe is slipping too. Three years ago, 80% thought that the EU could best solve their problems. Three months ago that was down to 65%. Now it is barely over half.
In Greece, Portugal and Ireland, Spain's “sweet bail-out” raised some hackles and some hopes. Portugal's prime minister, Pedro Passos Coelho, warned that he would scrutinise the final deal carefully. Syriza, a left-wing Greek party which wants to tear up the country's current bail-out agreement (see article) said Spain had shown the way. So did the centre-right: “Just think, at a time when a country like Spain negotiates, some”—a dig at Syriza—“argue that we have to clash with Europe,” said Antonis Samaras, the leader of New Democracy.
Meanwhile the markets swiftly moved on to other vulnerable euro-zone members. Cyprus is reported to be about to ask for a bail-out for its banks, which are heavily exposed to Greece. But the biggest worries are about Italy. Its budget deficit is small and its banks are not troubled by a burst property bubble, but it is in deep recession after a decade of almost no growth and investors are losing faith in the technocratic government of Mario Monti. His reform programme is seen to have stalled and he has less than nine months to go before the next election, the result of which is highly unpredictable.
Italy's public debt of almost €2 trillion makes it too big for any bail-out; after the latest €100 billion to Spain, the sum left for new lending commitments will be just €400 billion. And the response by the bond markets to that bail-out raises the worry that Spain might need to go back for more. Many of its regions can barely refinance their debts; they are largely to blame for Spain's deficit last year coming in at 8.9% of GDP not the targeted 6%. And while the banks may now be in slightly better shape, they are too risk-averse to lend to companies that, with credit, could grow. “The tragedy is that these €100 billion won't reach the real economy,” says Mr Encinar of Idealista.com. “The banks are petrified,” agrees MartínVarsavsky, who runs Fon, a Wi-Fi hotspot company. “They just want to save themselves.”
That said, Mr Varsavsky sees Spain as highly unlikely to end up in as much trouble as his native Argentina when it defaulted a decade ago. “Spain is much more mature and understanding of the role others can play in helping,” he says. “It is not a defiant, difficult country run by people who are abusive.” But it is still a country in a lot of trouble, likely only to be made worse when the Greek election result at least prolongs, and possibly intensifies, the euro zone's agony. Mr Rajoy may prove wise to have avoided the term “bail-out”: Spain could be shipping water for some time yet.