Not for the faint-hearted

May 25, 2012

With Spain’s banking system looking ever more parlous and the Damoclean Sword of Greek elections hanging over the financial markets, next week is not going to be for the faint-hearted.

Stock markets have endured another volatile week, rising early on before falling sharply just before the EU summit, then rising the day after – all this when very little changed on the euro zone landscape. Increasingly, the downward moves are sharper than the upward ones and there is little prospect of things settling before the June 17 Greek elections. It seems everyone is so nervous that if they are sitting on a day of gains, they cash them in double-quick.

Page one of the crisis management manual says get all the bad news out quickly. The handling of troubled Spanish lender Bankia has been an abject failure in that respect. First, the government said it would require about 9 billion euros to shore up, a few days on they are looking at 20 billion. One proposal doing the rounds is to create one nationalized bank out of a number of failed lenders. The big question, to borrow heavily from Louis XV, is: Apres Bankia la deluge?

It looks increasingly likely that Madrid will have to take a bailout for its banking system despite its protestations to the contrary. The money is there in euro zone rescue funds to cope but one of Spain’s only trump cards – that it had issued well over half the debt it needs to this year – may have disappeared after the government revealed that the publicly stated figure for the autonomous regions’ maturing debt — 8 billion euros for this year — is in fact more like 36 billion.

If Spain looked in real trouble (Greek contagion could play a part here) that might be the tipping point that persuades the euro zone to take more dramatic action. With German opposition to common euro zone bonds unbudgeable for now, a lot of the onus would fall on the ECB which, while deeply reticent to revive its bond-buying programme, could well be pushed into a third round of three-year money creation at some point. And if there was any sign of a bank run, plans for a deposit guarantee fund could have to be dusted off very quickly. Would that do the trick?

If Spain can be dealt with via existing bailout funds – if it comes to that – it may well be that, as it was last year, it would take Italy to come seriously into the firing line to push the ECB into overdrive. Italy will sell debt of varying denominations on Monday, Tuesday and Wednesday, giving plenty of scope for jitters. And there’s plenty else besides to keep longer-term investors on the sidelines.

Ireland holds its referendum on the new EU fiscal treaty on Thursday with the result expected the day after. Polls suggest it will pass. If it didn’t, the country would have a serious headache given it is under a bailout programme but would have rejected the debt rules the bloc is being asked to meet. While the treaty needs the approval of only 12 of the 17 euro zone countries to be ratified, an Irish rejection would be another scab for markets to pick away at.

The other bailout recipient, Portugal, has the troika of EU/IMF/ECB inspectors in town. Lisbon has done its level best to meet the terms of the programme but is struggling and may well need further outside help. But with the threat of contagion from Greece, if voters go the “wrong way”, it may be rewarded with looser budget targets, something that has been mooted for Spain too.

The EU summit showed there was no meeting of minds yet on relaxing fiscal timetables. On Wednesday, the European Commission publishes its annual policy recommendations to the 27 members states. Could that be the point that it signals Spain’s deficit-cutting path, and even Greece’s, is too ambitious?

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