Spain and the New Model

European officials are devising a new approach to the debt crisis.  The model used for Greece, which was the prototype for Ireland and Portugal, is being replaced by a new approach.  It is being hammered out in Spain.  It is evolutionary in the sense that it is responding to the changing environment and conditions, while at the same time the new approach uses mechanisms and approaches seen in the earlier model but uses them somewhat differently. 

There are three dimensions to the Spanish debt crisis:  the general government deficit, the bank problems and the regional debt.  Spain is moving on all three.

In exchange for additional time to reach its deficit targets, the government is agreeing to new savings measures.  The EU raised this year's target to 6.3% of GDP from the 5.3% agreed just four months ago after an initial target of closer to 4.3%.  Recall that in the first five months of the year, Spain recorded a deficit of 3.4% of GDP.  

Rajoy presented new austerity measures to parliament earlier today.  It calls for 65 bln euro in savings over the next 30 months and includes a 3 percentage point hike in the VAT, cuts in ministerial budgets, unemployment benefits, public sector employees forgoing year end bonuses, and a reduction in a number of other subsidies. 

Meanwhile, the draft of the memorandum of understanding about aid to Spanish banks has been leaked and it includes private sectors participation in the burden sharing.  Specifically, it requires any bank taking aid to wipe out/write off preferred shareholders and subordinated loans before aid can be granted.  

Spanish banks reportedly have about 67 bln euros in subordinated debt and hybrids.  Unlike in other countries, much of these have been sold to retail customers and there is much talk about lawsuits from uninformed or misinformed investors.  

Spanish banks receiving aid will also be required to finance part their own recapitalization efforts through the sale of non-strategic, non-core assets and stop paying dividends or any compensation on hybrid capital instruments.  Some Spanish banks have sizable stakes in several large Spanish corporations.  Bankia, for example, had a 20% stake in the large tech firm Indra, a 12% stake in the International Airlines Group, and a 5.3% stake in Iberdrola.  It also held stakes in an insurance company and an hotel operator.  

These are cited here for illustrative purposes and not equity recommendations of any sort. The point is that the banking reform could shake up the broader corporate ownership structure in Spain and weaken the linkages between industrial capital and finance capital. 

European officials now seem to recognize the need to severe the link between the sovereigns and banks.  However, how and when to do this is proving to be difficult.  The debate and negotiations appear to be continuing about whether Spain should still be required to guarantee against EFSF/ESM losses on loans to Spanish banks.  The creditors, of course, seem to be pushing for this, but the issue remains unresolved. 

Spanish banks will be provided with 30 bln euros by the end of the month, according to reports.  This is understood as the first tranche and a contingency reserve pending a more complete assessment (which means the auditors report due in late Q3).    Given that the ESM is not up and running, nor will it be any time soon (the German Constitutional Court ruling is still awaited, for example), Spain's funds will be drawn from the EFSF.  It is expected to eventually be transferred to the ESM.  

However, the  rub here, that few have yet to appreciate is all of the ESM's funding will not be available on day 1, when ever that is.  Specifically, the ESM will be launched with "only" 80 bln euros in paid up funds, with additional payments stretched out over a few years.  This does raise concern in some quarters that the an under-funded stability fund is an oxymoron.  

One linkage we expect to continue to expect to be strengthened in the new official approach is between sovereignty and solvency.  Spain will be required to transfer supervisory power to the Troika, which includes quarterly monitoring.  The Bank of Spain itself is expected to provide regular updates on the liquidity the banks receiving aid and has been asked to review its own supervisory procedures.  

A new mechanism to help secure funding for the regions is expected to be unveiled tomorrow and will likely insist on strong conditionality in exchange for support.   We are struck by the parallels between Madrid trying to address the region's debt and the euro zone trying to address the peripheral debt problems.  

Domestically, Rajoy takes on a similar role as the creditor nations do within the euro area.  He is willing to give support on terms that ensure that it is not endless.  Just as the euro zone nations that need aid have to cede sovereignty, Spanish regions that need assistance will be required to cede some of their independence.  

This is important.  It underscores our hypothesis that the creditor-debtor relationship is the key and has tended to overshadow other relationships.  It is not a moral issue, though some observers insist on discussing the issue in moralistic terms.  When an entity or country is a creditor, it acts like one.  When an entity or country is a debtor, it acts like one.  

Some times, other issues have obscured, mitigated, or even redirected the articulation of those interests.   We have suggested that the "comity of Europe" had  suppressed those interests to some extent.   The existential nature of the debt crisis has though undermined this comity and replaced it with the cash-nexus.