How Much Trouble Is Spain In? The EU?

by: David White

The economic uncertainty in Spain and in the EU in general is very high. Spain is already troubled by how to pay for the 19 billion Euro bailout of Bankia, which Spain nationalized recently as the first part of Bankia's rescue. Bankia still has many bad debts (estimated at 32B Euros). It could require even more funds in the future. The Bank of Spain has estimated that the country's banks are sitting on 180 billion Euros in tenuous assets due mostly to the real estate bubble there. Another source cited the Spanish government as saying that Spain has approximately 320B Euros in bad real estate loans. CNBC today gave this number as 400B Euros. The Spanish banks have been hiding real estate losses for years now, hoping for an economic upswing. That is clearly not coming soon. In fact Christine Lagarde has suggested that the EU may experience a "lost decade". It is time for Spain to pay the piper. The rating agencies have been downgrading Spanish banks aggressively in acknowledgement of this. For example, Moody's downgraded 16 Spanish banks in mid-May. Many other agencies have been doing the same thing.

The above is only the tip of the iceberg. Spain's central government has to refinance 117.5B Euros in debt by the end of the year. It must also fund 52B Euros due to this year's budget deficit during that same time. In addition, Spain's 17 autonomous communities need to refinance 36B Euros in debt, and they need to raise a further 15B Euros to fund their budget deficits for this year. The autonomous communities have even worse credit than Spain itself. Spain is still developing plans that will allow the autonomous communities to access the credit markets. All told the above debt sales will total 220.5B Euros, and that is before you figure in the likely tax shortfalls. It is before you add in what might be more than the probable 320B - 400B Euros the Spanish government/CNBC suggests is the amount necessary to cover the real estate bubble induced bad bank debts. Roughly 600B Euros is close to one half of Spain's GDP. This is tantamount to the US providing $6T to pay down its debt for one year. Ouch! FYI, using the US ten year treasury bond yield as a calculation basis (less than 2%), Spain would be paying only about 16B Euros in interest on roughly 800B Euros in debt. As it stands Spain would have to pay three times as much (about 48B Euros). The difference between this and the figure a country with the US' bond yield rate would have to pay is more than one half of the budget deficit of Spain for the year. Spain might be close to meeting the EU's requirement of no more than a 3% budget deficit, if it had Germany's borrowing rate.

The government estimates that the new austerity measures for this year will cost Spain -2.6% in GDP growth, and that is without figuring in any other factors. The Spanish retail sales data reported last week a 9.8% drop year over year. Spanish Industrial Production dropped 8.3% year over year in data reported June 6, 2012. The Spanish Manufacturing PMI was reported as 42.0 on June 1, 2012. This is significant contraction. At last report Spain's unemployment was 24.44%, and that figure is an understatement. Aliens are not included in the government figure, and there are a high percentage of unemployed aliens in Spain. The Chinese Manufacturing PMI for May was reported at 50.40. This was down from 53.30 the previous month, and it was below the expectation of 52.20. The Chinese HSBC Manufacturing PMI was even lower at 48.40. This has helped the negative feelings about Spain along.

Spain's central bank also reported recently that 97 billion Euros in capital had been pulled out of Spain in the first quarter. How is Spain going to grow its economy when it loses capital at a rate that is almost 10% of its GDP in one quarter (Q1 2012). Foreign investors are scared. They are selling Spanish assets, so they don't get fooled as they did by Greece. FDR used to say in his famous Fireside Speeches, "We have nothing to fear but fear itself." The Europeans do not have FDR, and they are not all part of one country. That very fact seems likely to be the undoing of the Euro.

If Spain's own problems were not enough, Greece's actions could significantly add to the Spanish banks' bad debt problems. Greece may vote to leave the Euro. The EU enforced austerity programs are hurting it economically. This is after its economy already shrunk by approximately 20% since 2008. Whether Greece remains in the Euro or leaves it, the Greek economy seems almost sure to shrink another 10% to 20% in the near future. This is a depression! If you think the people of the US are antsy, the Greeks are no longer sure they trust their banks at all. It would take very little stimulus to cause a run on Greek banks. Many pundits seem to think this would happen automatically with a currency changeover, if Greece leaves the Euro. The new elections are scheduled for June 17, 2012. Even if Greece decides to stay in the Euro, it is clear now that that will not be the end of the Greek tragedy. Bank runs will continue to be an issue in Greece. Money is already moving out of Greek banks and Greek assets. Inevitably we will see bank runs in Europe this year. Keep in mind that many Europeans have real estate loans through Swiss and German banks, which tended to have lower rates. They were also more stable. The Swiss, Germans, and French are the biggest bankers in the EU, and they have by no means lent only within their own countries. If Greece were to withdraw from the Euro, that could cause a massive devaluation of Greek assets. That could cascade into other PIIGS, and so on. If mass real estate devaluations occur in some or all of the PIIGS, the Swiss, German, UK, and French banks will be hit hard too. Among one analysts' top twenty most exposed to the PIIGS banks are the following non-PIIGS banks: Dexia (Belgium), Commezbank (Germany), BNP Paribas (France), Deutsche Bank (Germany), Credit Agricole (France), KBC Bank (Belgium), DZ Bank (Germany), Landesbank Baden-Wurttemberg (Germany), Barclays (NASDAQ:UK), Landesbank Berlin (Germany), and Royal Bank of Scotland Group (UK). Eleven of the twenty most exposed banks are not PIIGS' banks. Almost any big credit event will mean a severe recession for the PIIGS, but it will also mean big trouble for other EU economies, even Germany. Notably Commerzbank (OTCPK:CRZBY) was one of the six German banks recently downgraded by Moody's. Deutsche Bank (NYSE:DB) is still waiting to hear its fate. Any big EU credit event could easily drag the US into a recession and China into a hard landing. A Chinese hard landing could mean an eventual Chinese recession. The world could become a very depressing place.

Does this mean you should run for cover? In a word, YES. However, it is appropriate to remember the words of FDR. Fear can create its own reality. You may want to stay invested to some degree. Stocks will eventually rebound, presuming they fall further due to the above troubles. However, you do not want to be the one holding onto a small cap growth stock as it shrinks to one tenth or one twentieth of its value. It makes sense to put your money in some of the biggest and most reliable stocks. Blue chip stocks are again "good". You can collect good dividends, while you wait for them to recover from any fall they may experience. Some truly excellent stocks may even continue to rise. Evaluating the RISK in today's market may be the most important element in your investing strategy.

Good Luck Trading.

Disclosure: I am short DB.