Why didn’t Europe bail out Spain’s banks directly?

By Felix Salmon
June 10, 2012
The FT has the best explanation of the way that Europe has this weekend agreed to bail out Spain's banks.

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The FT has the best explanation of the way that Europe has this weekend agreed to bail out Spain’s banks. Impressively, the whole deal was done on Saturday, in good time to let all the Spanish negotiators spend Sunday preparing for and watching Spain’s big opening match against Italy in the European Cup. (Portugal lost today; Greece had a draw on Friday; and Ireland isn’t in the tournament plays Croatia tomorrow. According to the odds, Spain has the highest chance of winning both the PIIGS subset and the tournament as a whole.)

The big question, going into this weekend, was whether Europe would be willing to recapitalize Spain’s banks directly, or whether it would simply help Spain bail out its banks. And the answer seems to be somewhere in the middle. Europe is going to lend money to Frob, which is basically the Spanish Tarp; Frob, in turn, will use that money to recapitalize the banks.

So really there are two bailouts here. The Spanish government is getting debt finance from Europe, and the Spanish banks are getting equity finance from the Spanish government. Because the money is ultimately going to the banks, the Europeans and the Spaniards have an excuse for not imposing tough austerity conditions on Spain. And that’s good: Spain has never been fiscally profligate in the way that Greece was, and there’s no reason why it would ever benefit from some kind of Germanic nanny double-checking and second-guessing every check it writes.

On the other hand, all the money for bailing out Spain’s banks is immediately going to become Spanish sovereign debt. And that’s not good, for anyone worried about the Spanish fiscal situation. What’s more, it’s unclear how much of the money is going to come from the ESM rather than the EFSF. That might seem like a niggardly distinction, but it’s an important one: the ESM has preferred-creditor status, which means that it’s senior to anybody buying Spanish sovereign bonds. And as a result, at the margin, the more ESM debt that Spain has, the higher the spread on Spanish government bonds, since every euro of ESM debt effectively subordinates every euro owed by the Spanish government to bondholders.

The way to avoid all this would have been for Europe to recapitalize the Spanish banks directly, rather than doing so by lending money to Frob. The IMF couldn’t participate in such a plan, since it can only lend to governments, not to banks — but the IMF isn’t participating in this plan, either. And by taking equity in the Spanish banks, Europe would actually have a chance of turning a substantial profit on the whole operation, instead of just lending money to Spain at concessionary rates. As it is, if the equity that Spain takes in the Spanish banks ends up rising in value, all that rise in value will accrue to the government of Spain, rather than to the Europeans who provided the money.

But clearly Europe hasn’t yet reached the point at which it’s willing to directly help out the financial sectors of member countries, no matter how necessary or potentially profitable that might be. Taking equity stakes in Spanish banks — or any other private-sector institution, for that matter — is clearly something which Europe wants to leave to individual countries, and I can understand that, at least in theory. In practice, however, I suspect that Spain and the markets would have been much happier if the flow of money had been direct, rather than being intermediated by the Spanish government.

28 comments

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Ireland ARE in the European Championships Felix. Play Croatia on Sunday. Don’t take away our only spark of light by claiming we aren’t!

Posted by cg6000 | Report as abusive

Um, Ireland is in Euro 2012:

http://www.uefa.com/uefaeuro/season=2012  /teams/team=64/index.html

They are called the “Republic of Ireland,” FYI. Not Irish, but thought you should know.

Posted by Loofah | Report as abusive

Ok, all this is fine and thank you for that. But can we get to more serious business of UEFA 2012 Championship?

Felix, you don’t get it – what do young European Male and productive Female live for? It is all about that Football. So please go away for next few weeks – first UEFA followed by London Olympics; we have got plenty of opium to keep we Europeans out of ‘dangerous news’. Let rest of the world bother about that or if possible take a ‘tab’ for that; we are busy here in Europe.

Posted by umeshgeeta | Report as abusive

** peers in cautiously **

Is it OK to talk finance rather than football?

Pretty clear to me why the Euro pols went with indirect aid, via the sovereign, rather than direct aid to Spanish banks. The precedent was set in Ireland, where taxpayers/government who had behaved at all times with fiscal prudence were coerced by Germans and French to guarantee all the debts of a profligate financial sector so as to protect their foreign creditors. ‘Treason’ is an ugly word, but Irish citizens might want to check the legal definition anyway.

Had the Euro pols let Spain get away with something less onerous than what the Paddys were compelled to bend-over and take up the back side, no tellin’ what the reaction might have been in Éire. If you’re wondering why the irresponsible lenders to Irish and Spanish banks don’t have to stand the loss, and taxpayers do – that makes two of us. (Not meaning to suggest we were butt …. any less in the US. Just sayin’ ….)

** flees from enraged Felix-football-hooligans **

Posted by MrRFox | Report as abusive

Aren’t the banks over there buckling under the weight of the sovereign debt. Who would you bail out, the debtor or the debtee?

Posted by Woltmann | Report as abusive

OK, let me see if I understand this correctly: There is an order of going bust, and nobody wants to upset it. First, the banks go bust. Then, countries go bust. And finally, the euro goes bust. The whole idea is that everybody is hoping that it won’t go as far as the euro, and things can be firewalled at some previous step. Right?

Posted by Doly | Report as abusive

“As it is, if the equity that Spain takes in the Spanish banks ends up rising in value, all that rise in value will accrue to the government of Spain, rather than to the Europeans who provided the money.” – profit?! rise in value?! They’re broke…

Posted by sw12 | Report as abusive

Felix, you’ve put the Spanish argument very well, but managed to avoid the rules, or the politics. There would have been no agreement on Saturday if your plan had been followed – because the rules of the ECB forbid that sort of thing. To change the rules needs a Treaty change, and to get that you have to hold Referenda in multiple European countries, and even if the populations of Portugal, Italy, Ireland and Greece let Spain off the hook (I don’t think they would) the whole think would reek of “European Superstate” through the back door – and that would put off the French, and the Germans, and the Eurosceptic Tory Brits would shout and scream and disrupt everything in which they still have not managed to cede total influence to the European Core countries to through their ‘we turn our back on you’ approach.

As for the profitability of any equity shares in the Spanish banks (strictly speaking it isn’t the Banks, but the Cajas that are the problem), look at the British case. Labour Prime Minister Gordon Brown put together a deal that worked economically and politically for him: as a socialist he was happy to own a stake in mainstream British Banks, but as a Scot he was not happy about losing money on the deal and was happy to wait until the banks recovered before selling the shares back at a profit – or certainly not at a loss (Northern Rock).

The current Tory right wing led government, and George Osborne the Chancellor in particular, hate the idea of any state ownership of any bank, and holding onto any shares in them is burning their fingers so much that, despite supposedly thinking of themselves as the party of financial probity they have sold many bank shares off at a loss, blaming the loss to the country’s finances on Gordon Brown from the previous government.

The more pragmatic LibDems, and Vince Cable in particular (the man most qualified to be Chancellor with a Doctorate in Economics and a career as a CFO of an oil major) want to use the government’s power to force the banks to support British business, but the laissez faire ‘New Tories’ are fighting that idea as much of their political funding comes from bankers and they don’t want to do anything that hurts their paymasters financially (don’t confuse bankers with banks here).

So, the solution provided yesterday to put the cash in the right place, and quickly, is probably the right result. But politics is a messy business, and I now wonder what the Greek reaction will be on 16th June…

It may be that the feeling was amongst the European politicians that agreeing something for relatively painless for Spain that could cause a protest vote in Greece for one of the extremist parties could end in a Greek voluntary exit from the Euro with no Eurozone politician or country being blamed for the Greek intransigence. After all, wasn’t it the Greeks who lied about their finances for years anyway?

Contagion may have been avoided here, and my feeling is that is the direction the firewall is going. But following politics is great – it can change in a sneeze!

Posted by FifthDecade | Report as abusive

” The IMF couldn’t participate in such a plan, since it can only lend to governments, not to banks — but the IMF isn’t participating in this plan, either.”

Same for EFSF/ESM, as it stands, they can only lend to member states.

Posted by alea | Report as abusive

The Euro currency experiment is falling apart because its architects were over optimistic thinking it was possible to get all member nations to pull in the same direction and get somewhere…

“Thou shalt not plow with an oxe and an asse together.”

Posted by reality-again | Report as abusive

China can either export or consume. It can’t do both. China = the greatest consumer on the planet.

Posted by Woltmann | Report as abusive

Spanish labour market used to be a straightjacket, if you’ve got a job, can’t be fired easily or at all. Youngsters thus never got a chance, now jobless rate seemingly for youngsters at 45%. Until that rigidity is changed, things won’t get better.

Posted by CorradoCam | Report as abusive

spanish arrangement is a premeditated “au revoir/αντίο” to greece

Posted by scythe | Report as abusive

Spain has been less profligate than Greece? Well, if you mean they were able to take in plenty of tax revenue courtesy of a real estate bubble, then I guess you are right. But, how about the level of Spanish government spending? I hardly believe Spaniards have been poster children for thrift. And, right now, Greece is close to a primary surplus, whereas Spain is estimated to have debt to GDP of around 8.5%, if it gets lucky. So, who is profligate now? It seems to me that Spain was deemed to big to fail, but, it has failed and will fail. The EU is just kicking that can down the road, but I guess that is what passes for prudent management now. As far as Greece, why shouldn’t it vote for Syriza expecting a break, too? Certainly, a vote for Syriza puts Greece in a better bargaining position with regard to its German taskmasters.

Posted by madridisburning | Report as abusive

You’d imagine someone in Europe would have learned something from the German reparations crises of the 20s and 30s. Basically, Germany was trying to repay a large sovereign debt with a moribund economy and no mechanism for stimulus. This meant crisis after crisis with repeated restructurings and write downs. It also meant a major depression in Germany, Europe and elsewhere that was only ended by economic stimulus in the form of World War II. (Ivar Kruger’s last big deal was a $50M loan to Germany before he blew his brains out. Then, as now, there were plenty of lenders.)

Saddling Greece, Ireland, Spain and probably five or ten other nation with major crippling debt that is unlikely to ever be repaid is not a formula for recovery. (Neither is arming for WWIII, for that matter.) It would make more sense to let the financial sector in Spain and its creditors just take their losses and go out of business if they are overwhelmed. There is already a firewall in place. That’s the whole point of a limited liability corporate structure.

The Spanish government should just take on the business of retail banking directly and use the capital being provided for the bank bailout as seed money. The financial sector is just dead weight, and the sooner it is thrown overboard, the better.

Posted by Kaleberg | Report as abusive

It’s all about Europe
http://www.cnhedge.com/thread-7758-1-1.h tml

Posted by cnhedge1 | Report as abusive

I think the question that the post is trying to answer is not important, it is rather irrelevant. What matters is that there is officially another sick patient and no quarantine in place.

Posted by Tseko | Report as abusive

Felix,

As the old saying goes, “even a stopped clock is right twice a day”, but typically you can’t beat even a stopped clock.

(1) If the Spanish banks were bailed out directly, when they failed (and they will fail shortly) the EU (meaning Germany) would get stuck directly with the debt from the collapsing banks.

(2) The present EU treaty does not allow the EU to bail out banks directly, only sovereign nations, which must (should) use the money to bail out their own banks.

So, no, there wasn’t “really … two bailouts here”.

Also, the underlying reason that Spain wasn’t required to impose more stringent austerity measures is that the Spanish government CAN’T impose its will on the autonomous regions within Spain.

In recognition of this (and as an inducement for the Spanish government to accept the bailout) Germany “cut them a deal” on Saturday.

At least TRY to understand a situation before writing about it!

Posted by Gordon2352 | Report as abusive

“Niggardly:

word that will get u fired…even though it doesn’t mean anything offensive”

Urban Dictionary

http://www.urbandictionary.com/define.ph p?term=niggardly

Posted by agentgreg | Report as abusive

When dealing with crony capitalism always lend to the bigger crony.

Posted by mulholland | Report as abusive

@ fifth decade
“The more pragmatic LibDems, and Vince Cable in particular (the man most qualified to be Chancellor with a Doctorate in Economics and a career as a CFO of an oil major) want to use the government’s power to force the banks to support British business, but the laissez faire ‘New Tories’ are fighting that idea as much of their political funding comes from bankers and they don’t want to do anything that hurts their paymasters financially (don’t confuse bankers with banks here)”.

I don’t know of any govt. that doesn’t want its banks to lend to its industries!
The “New Tories” as you call them,have set healthy targets for bank lending to UK industry,but its being undershot.Industry isn’t going to the banks and taking them up on that lending,presumably they are looking for some light at the end of the tunnel.
And i don’t imagine that there are many bankers out there who are anticipating getting a bumper bonus payout by sitting on their money!.

Posted by kingdig | Report as abusive

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