Greece is Worrisome, but Don't Forget about Spain

Greece's difficulty in putting together a government is weighing on euro sentiment. Although Belgium went without a government for more than a year, Greece does not have that luxury. The Troika is set to visit Athens next week for the periodic progress report. Another 11.5 bln euro in savings in needed to be identified by the end of June, otherwise is may not receive the next tranche of aid. While this may seem like deja vu, the important difference is that this time creditors are in the official sector rather than the private sector. Even more telling and incestuous, the Troika themselves are overwhelmingly Greece's largest creditors. At the same time, there is concern that without the next cash infusion, the Greek government may run out of money by the end of next month, two weeks after the next election, should that prove necessary.

Developments in Spain are also worrisome. The economy is collapsing. On a work day adjusted basis, industrial output is 7.5% below year ago levels and the contraction is accelerating. At the same time, the bank that was a combination of seven institutions and is the largest holder of real estate loans on its books, Bankia is on the proverbial bubble. Reports that is has been nationalized have been denied, but the stock is still bleeding. Talk that the government would inject at least 10 bln euro into Bankia, with an announcement by the end of the week failed to stabilize sentiment.

Nationalization seems to be back on the table and it is this talk that seems to be helping the Spanish stock market recover late in the session, with financial participating. The resignation of Rato--former IMF managing directors-by Bankia and appointment of the former CEO of BBVA is consistent with the nationalization story, though the sums involved may be closer to 20 bln euros than 10 bln.

Bankia shares are now off 40% since it went public last July. It was the centerpiece of the banking reform and restructuring. Although Rajoy was not the PM at the time, his government has generally support the approach and the mess will have to be addressed on his watch. Uniting a number of weak banks has failed to create a strong bank.

Rajoy has repeatedly promised that it will not inject any more tax payers money into the banks, but principle is about to be jettisoned. He is quoted now saying that if using public money "were necessary to save the financial system, I would not renounce" it. Spain has already spent more than 100 bln euros to boost liquidity and solvency of the banks.

The government has argued that banks would cover any losses not covered by the 54 bln euro provisions they have been ordered to set aside. However, private estimates suggest something on the magnitude of at least twice this will be required and this is without the property and house prices have fallen to levels that will clear the market.

One proposal was that Spanish banks should be allowed to borrow from the EFSF/ESM. However, this seems to be a non-starter at this juncture. Borrowing from such facilities, including the IMF, comes with all sorts of conditionality which would not apply to the private sector. If Spain were to borrow just for its banks, it would have to be as part of a traditional package with the traditional strings.

The injection of capital into Bankia or its nationalization is not a credit positive event. A downgrade by Moody's or Fitch, which would bring their rating in line with S&P, remains a distinct possibility as early as next week.