Spain Wisely Favors Stress Test

by: Markos Kaminis

Spain, while under financial stress, is seeking to employ financial stress tests upon its banks. The action could prove the perfect medicine for what ails Spain, providing investors comfort in the condition of the Spanish banks and potentially alleviating pressure on Spanish borrowing costs.

Spain auctioned off long-dated government bonds today. With Spanish yields pumped and bond prices relatively low, and with Spain seemingly still distant from disaster, domestic demand for the new issuance was strong. The Spanish Treasury sold a combined EUR3.479 billion of the 4% April 2020 and 4.70% July 2041-dated government bonds, just slightly short of the upper end of the EUR2.5 billion to EUR3.5 billion range it targeted. It actually received EUR6.83 billion worth of bids for the bonds, so the news was somewhat reassuring this morning.

Still, like Greece, the Spanish government contends against paying high yields for its borrowings which the Europeans tend to blame on speculators. The spread on Spanish government bond yields over German bunds, the eurozone benchmark, Thursday reached their highest levels since the introduction of the euro currency. The average yield on the 10-year bond marked 4.864%, compared with 4.045% at the previous auction in May.

Those who understand market dynamics know that anomalies work themselves out if profit does not follow a trade. So, patience is warranted in Spain and Greece, though definite and creative financial efforts are wise now to secure financial stability, and in turn, bring borrowing costs down. I say creative, because I believe simple direct taxation and budget cuts are ill-timed now and too ambitious; they threaten to do significant damage to the Greek economy, and the same applies to Spain. I reiterate my often-stated belief for the same reason Ben Bernanke professes against such action in the US; it's because it is precisely the wrong action to implement during recession (lessons learned from the Great Depression). I again say, spread out austerity over a longer time span, support your EU brethren, and find more creative ways to restore fiscal responsibility.

Spain is engineering an effort to mitigate its borrowing costs, and it is employing a borrowed idea from the US Federal Reserve's recent history. Germany is boldly pushing its EU partners to publish bank stress test results, which might help to support the Spaniards (considering they want it). We are assuming Greece would rather not know what lies beneath the balance sheets of its local money lenders, though we hear the National Bank of Greece (NYSE: NBG) has diversified risks and might be fine.

It's possible that enough other (i.e. Hungary) nations have something to hide to keep the stress test results from being published in detail. The tests are currently underway, but a previous test led to a vague release of information, rather than the detail that would truly appease the market.

The Europeans just don't get it when it comes to market psychology. Investors will not take a vague reassuring statement seriously. European cluelessness on this topic is what drove Greece to the cliff's edge. The market wants transparency and action. Kudos to the Spaniards for moving forward in this way, but let's see what gets published before we raise their hand in the air. The Spaniards face significant borrowing repayments in July, and high borrowing costs must not persist for Spain to avoid trouble. In case you did not realize it, it is the pressure of the bond market that has Spain and others moving preemptively. Thus, the free market is acting in a favorable manner, pushing financially irresponsible nations to get their act together.

Disclosure: No positions