Spain facing grave danger

Spain faces 'total emergency' as fear grips markets

Spain is facing the gravest danger since the end of the Franco dictatorship as the country is frozen out of global capital markets and slides towards an epic showdown with Europe.

By Ambrose Evans-Pritchard,

The Telegraph,

1 June, 2012

“We’re in a situation of total emergency, the worst crisis we have ever lived through” said ex-premier Felipe Gonzalez, the country’s elder statesman.

The warning came as the yields on Spanish 10-year bonds spiked to 6.7pc, pushing the “risk premium” over German Bunds to a post-euro high of 540 basis points. The IBEX index of stocks in Madrid fell 2.6pc, the lowest since the dotcom bust in 2003.

Chaos over the €23.5bn rescue of crippled lender Bankia has led to the abrupt resignation of central bank governor Miguel Ángel Fernández Ordóñez, who testified to the senate that he had been muzzled to avoid enflaming events as confidence in the country drains away.

Markets are on tenterhooks as Spanish yields test levels that forced the European Central Bank to respond last November with its €1 trillion liquidity blitz. “Nobody is short Spanish debt right now because they are expecting ECB intervention,” said Andrew Roberts, credit chief at RBS. “If it doesn’t come -- if we take out 6.8pc -- we’re going to see a hyberbolic sell-off,” he said.

Italy felt the full brunt of contagion from Spain on Wednesday, with 10-year yileds back near 6pc. The euro fell to a 2-year low of $1.239 against the dollar. Crude oil and metal prices plummeted and save-haven flight pushed rates on 2-year German debt to zero. Gilt yields fell to 1.64pc, the lowest in history.

Mr Roberts said the collapse in Spanish tax revenues is replicating the pattern in Greece. Fiscal revenues have fallen 4.8pc over the last year, and VAT returns have slumped 14.6pc. Debt service costs have risen by 18pc.

The country is caught in a classic deflationary vice: a rising debt burden on a shrinking economic base. “Once you get into such a negative feedback loop, you can move beyond the point of no return quickly,” he said.

The European Commission has softened its stance, giving Madrid an extra year until 2014 to cuts its budget deficit from 8.9pc to 3pc of GDP, though this still amounts to a fiscal shock. Brussels told premier Mariano Rajoy to widen the VAT base and speed retirement at 67.

There is no sign so far that the ECB is ready to relent as Frankfurt and Madrid cross swords in an escalting test of will. The ECB has scotched Mr Rajoy’s tentative plans to recapitalize Bankia by drawing on ECB funds.

“It is dangerous to play chicken when you are driving a Seat and the ECB is driving a tank,” said professor Luis Garicano from the London School of Economics (LSE).

Mr Garicano said Madrid has overplayed its hand but the ECB needs to be careful too since Spain is increasingly tempted by the example of Argentina, which recovered quickly after leaving its dollar-peg. “The Rajoy people will do anything to avoid the slow agony of Greece. There is massive disaffection with the euro in Spain and papers like El Pais and Vanguardia are turning anti-German,” he said.

The latest PEW survey shows that just 37pc of Spaniards think the euro has been good for the country. Most still want to stay within EMU but the number is falling fast. The survey found that 40pc of Italians want to return to the lira.

The ECB is pushing Spain to accept a loan package from the EU bail-out fund (EFSF), the proper body for fiscal rescues. Mr Rajoy has refused vehemently. Any recourse to the EFSF is viewed with horror in Madrid, entailing an unacceptable loss of sovereignty.

The result is paralysis as both sides refuse to shift ground. Mr Rajoy is clinging to hope that the EU will take care of Spain’s banks through an EMU-wide recapitalization plan. This would avoid stigma and draconian conditions.

Brussels floated the idea on Wednesday for a eurozone “bank union” and use of the European Stability Mechanism -- which has not yet been ratified by most states -- to rescue banks and sever the dangerous nexus between crippled lenders and crippled states.

The proposals were shot down instantly by Berlin. Such plans amount to debt-mutualization, a form of back-door eurobonds. German opposition is “well known”, said the Kanzleramt.

Sources in Berlin say Germany wants Spain to tap the International Monetary Fund -- as well as the EU -- to spread the rescue burden to the US, China, Japan, Britain and others.

LSE Professor Paul De Grauwe accused the ECB of cherry-picking treaty clauses to justify inaction and failing to carry out its crucial mandate of financial stability. “They should buy Spanish and Italian bonds to cap yields at 300 basis points over Bunds, and let the lawyers argue about it for the next ten years,” he said.

Eurozone data released on Wednesday show that private credit and all key measures of the money supply contracted in April, suggesting that ECB’s €1 trillion liquidity blitz over the winter has failed to gain traction.

Guy Mandy, credit strategist at Nomura, said the ECB has lost sight of the big picture and risks losing the euro altogether if if fails to restore basic confidence. “They need to weigh up events on a grander scale, stop worrying about moral hazard, and do the job of a central bank,” he said.

Capital Flight Intensifies to Record Levels in Spain; Outflows Make Spanish Banks Increasingly Reliant on ELA Funding

Mish's Global Economic Analysis,

31 May, 2012

Here is a note regarding capital flight in Spain and Greece that I received via email.

Capital flight has intensified to record levels in Spain but interestingly leveled off in Greece. Capital flight from Greece is expected to resume when next reported given statements by the Greek president.

The original source of this information appears to be Credit Suisse AG.

 Spanish private Sector Deposit numbers dropping at a faster rate

The Spanish bond markets continue to be viewed with both suspicion and concern by would be investors, with the shocking size of the Bankia bailout send clear warning signs of what else might yet emerge from the Spanish banking sector. Investors were also unimpressed by what appears to have been a very poorly thought out strategy for recapitalising Bankia, with the ECB indicating that they were not consulted by the Spaniard’s before the bonds-for-repo strategy was announced. The Spanish government has lost further credibility because of its handling of this issue, and has since announced that it will indeed have to raise cash from the markets and use the proceeds to recapitalise Bankia.

The ECB published the latest aggregated balance sheet of the euro area MFI’s on Wednesday, which contained the usual array of interesting and relevant data. The Spanish numbers were obviously in focus given the markets current attention to the Iberian peninsula. The data showed that the run up in bank buying of Spanish Government bonds came to an end in April, with a net reduction of €3.3bn in holdings being recorded at month end.

The private sector deposit numbers were also closely looked at, with April seeing a huge €31.5bn reduction in deposits being placed by households and non-financial corporates. This was close to the all time record outflow posted back in January 2010, though that number was driven by year end reporting factors. The April 2012 number appears to be much more significant, and is likely to be repeated in May. Over the last 7 months the net reduction in Spanish Private Sector Deposits has now totalled €92.2bn. These outflows make the Spanish banks increasingly reliant on ELA funding via the Bank of Spain.

Interestingly the ECB data showed that the recent deposit flight reported in Greece appears to have levelled off, with the amount of private sector deposits actually increasing by €400mn in April. This was the second consecutive monthly increase, after two large outflows were reported in January and February. Given the commentary from the Greek President earlier this month we would expect to see a sharp increase in outflows when the May numbers are reported at the end of next month.

At an aggregate level it remains quite clear that most of the deposit outflows from the peripheral nations are being recycled to other parts of the euro-zone. Germany and Holland in particular have seen large inflows of deposits in the months where the peripheral nations have seen outflows. These balances are effectively getting recycled back to the home country each day, via the ECB’s TARGET 2 cash management system. As the inflows get larger so too does the TARGET 2 imbalance, causing even greater cross border systemic risk. The Bundesbank in particular has been awake to this issue for some time, noting that the risk of losses is high if a debtor nation does decide to suddenly leave the euro-zone.

Money flies out of Spain, regions pressured

Spaniards alarmed by the dire state of their banks are squirreling money abroad at the fastest rate since records began, figures showed on Thursday, and the credit ratings of eight regions were cut

Reuters,

31 May, 2012

Spain is the next country in the firing line of the euro zone's debt crisis, with spendthrift regions and shaky banks threatening to blow a hole in state finances and pushing funding costs towards levels that signal the need for a bailout.

The European Commission gave new help on Wednesday, offering direct aid from a euro zone rescue fund to recapitalize Spanish banks and more time for Madrid to reduce its budget deficit.

That helped lower the risk premium investors demand to hold Spanish 10-year debt rather than the German benchmark on Thursday, but it remained close to the euro-era record, at 520 basis points.

Bank of Spain data showed a net 66.2 billion euros ($82.0 billion) was sent abroad last month, the most since records began in 1990. The figure compares to a 5.4 billion net entry of funds during the same month one year ago.

Spaniards are worried about the health of their banks, hit by their exposure to a 2008 property crash, and have been sending money to deposit accounts in stronger economies of northern Europe.

The capital flight data predates the nationalization of Spain's fourth biggest lender Bankia (BKIA.MC) in May when it became clear the bank could not handle losses from bad real estate investments, compounded by a recession.

Spain's centre-right government has contracted independent auditors to assess the health of its financial system in an effort to restore faith in its banks.

Spain must lay out its restructuring plans for Bankia to the European Commission (EC), a spokesman for the EU executive arm said on Thursday. He added that a domestic solution to the country's bank crisis would be better than a European rescue.

The government said on Wednesday it would finance a 23.5 billion euro rescue of the bank through the bank fund, FROB but senior debt bankers said that the syndicated bond market is currently closed for Spanish agencies.

REMOVING UNCERTAINTIES

The prospect that Spain might not be able to handle losses at its banks has pummeled shares and the euro, although both regained some stability on Thursday.

"What we need first of all is for the Spanish government to tell us its restructuring plans for Bankia, what options it is considering," said European Commission spokesman Amadeu Altafaj in a radio interview.

"From there, we will study the plans and see whether they comply with requirements for public aid."

Spain should carry out the refinancing of its banking sector, laid low by a decade of unsustainable lending during a property boom, by market mechanisms or government funds, rather than a European rescue which would have negative connotations, Altafaj said.

"The sooner uncertainties are removed the better," he added.

The government also hopes to clear doubts on Friday about how it plans to ease financing problems among its 17 autonomous regions.

Treasury ministry sources said a mechanism to back the regions' debt would be agreed at the weekly's cabinet meeting and figures showing they were on track to meet their spending cuts targets would be released.

Fitch Ratings downgraded eight regions on Thursday, warning that a failure from the government to adopt new measures would result in further ratings cuts.

Spain's Deputy Prime Minister Soraya Saenz de Santamaria is due to meet U.S. Treasury Secretary Timothy Geithner and International Monetary Fund Director General Christine Lagarde in Washington on Thursday.

The deputy PM will outline Spain's measures to tackle its crisis during the meetings, which were convened before Spain's situation reached boiling point, a government spokesman said.