Spain's Debt Crisis: The Uncertainty Continues

Includes: EWP
by: Investment U

By Jason Jenkins

Spain is in trouble…

If you keep back-peddling on a cliff, there comes a point where you just run out of real estate.

I wrote extensively on the problems of Greece and its second bailout. With all the headaches that Athens gave the European Union and world markets, you knew that it was still a small fish. Italy and Spain were the big problems. Each were headed to an "economic bad place" down the road and there was no sufficient firewall set in place by either the European Central Bank or the European Financial Stability Facility to prevent this from happening.

ECB Measures Inadequate…

The European Central Bank's emergency lending program launched at the end of last year was intended to give Europe's troubled banks relief for the next three years. But just months later, we're headed into another crisis - one larger than last fall's drama.

The ECB allotted $643.18 billion in the first installment of the loan program - and this was more than investors expected. The loans went to 523 banks in the Eurozone to support bank lending and liquidity.

As Bloomberg's Peter Coy wrote, "That's the problem with trying to fix a solvency problem with liquidity - it doesn't last. To put it in terms more familiar to a homeowner, it's like borrowing more money to tide you over when the real problem is you don't have a job."

Not Much Confidence in Spain

A slide in Spanish stocks and bonds deepened as investors' concerns that Prime Minister Mariano Rajoy may require international aid. Spain has become the focus of investor concerns with many worried about the ability of the government to push through a big austerity program at a time when its economy is heading for a return to recession and unemployment stands at a staggering 23%.

The yield on Spain's 10-year benchmark bond has jumped nearly one percentage point since March 2, when Rajoy announced the government would miss its budget-deficit target this year. He set the target for 2012 at 5.3% of gross domestic product - lowering it from 5.8% under European Union pressure - instead of 4.4% and warned public debt will surge to a record 79.8% of GDP as it imposes the deepest austerity in at least three decades.

Here We Go Again…

There are some big issues going forward that someone is finally going to have to deal with. As I stated before, Spain - and Italy for this matter - are far more of a problem than Greece is just by mere size alone.

  1. According to Citibank's Willem Buiter, the reason Spanish sovereign debt was held in check for the last four months was due to the ECB three-year liquidity injection into the banking system, as Spanish banks are the main buyers of newly issued Spanish sovereign debt. When you have no new money coming in, you can't finance yourself.
  2. Spain is on track to fall into a similar self-defeating austerity cycle where austerity leads to negative growth and tax receipts, needing more austerity and ratcheting up the debt/GDP ratio just like in Greece.
  3. The decline in Spanish land and property prices appears far from complete (probably less than half complete). The General IMIE Index, an indicator created by Tinsa to analyze the evolution of house prices in the Spanish market, increased its year-on-year decline in February, and fell by 9.5% - returning to the levels of 2004. The cumulative decline in the General IMIE Index from the top of the market in December 2007 was 27.1%. New property and real estate-related losses are likely to come their way as a result of further property price declines. The Spanish banks are unlikely to be able to absorb these losses

What to Take From This

It looks like we're in store for some more European turmoil and uncertainty. What we hope is that EU dysfunction has been priced out of U.S. markets and that global issues won't affect our banks - one of the provisions of the Fed's stress tests last month.

But another immediate EU sovereign debt crisis would definitely have a more adverse effect on China and certain emerging markets. This is something to definitely keep your eye on when investing in the upcoming months.

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