Why are the markets so unimpressed with Europe’s new plan to rescue Spanish banks? The short answer is that if the “up to” €100 billion was all it took to solve the European crisis, it would have been solved long ago.
The plan doesn’t address the payment imbalances that have grounded the peripheral economies, nor the austerity that threatens them with depressions. And though the upper bound of the promised credit is impressive relative to the Spanish banks’ current presumed needs, it probably won’t cover the worst-case scenario for future losses as the housing bubble continues to deflate.
The measure is another short-term symptom fix, deservedly derided by traders as a band-aid on a cancer tumor. In fact, it may make the cancer worse, by reminding Spain’s creditors that this bailout, like all future ones, will in all likelihood subordinate their claims to the new ones taken on by official lenders. This is exactly how Greece’s creditors ended up getting cents on the dollar.
This is why the strong equity, euro, and commodity rallies overnight unwound as soon as holders of Spanish and Italian bonds tried to unload them. The yield on Spain’s ten-year Treasury note, which slipped as low as 6.02% by the dawn’s early light, shot up to 6.51% at the close. Italy’s ten-year yield went from a low of 5.62% to 6.03% by the close, just off its highs.
Inevitably, shares of Spanish and Italian banks loaded to the gills with national bonds followed those bonds lower, so that the Spanish stock market’s 5% initial pop fizzled to a 0.5% loss on the session.
Worse, the posturing associated with the bailout in Madrid and Berlin suggests that European elites still don’t get the gravity of their situation.
For example, Spanish Prime Minister Mariano Rajoy reportedly reveled in his newfound leverage over Germans unwilling to face eurozone breakup. “Resist, we are the 4th power of the EZ. Spain is not Uganda,” he allegedly texted to his finance minister.
Afterward, Rajoy pitched the deal at home as a triumph protecting Spanish sovereignty, while mentioning as an aside that the recession and unemployment are likely to get worse in the near term. And then he jetted off to Poland to watch soccer.
This is another symptom of institutional denial from a government that’s always remained a step behind throughout the crisis. It underestimated the severity of its fiscal problems and the recession, and as leading Spanish daily El Pais points out, it has made a hash of past efforts to restructure the banking sector.
Now Spain will have to devise a though recapitalization in concert with its European rescuers. And even if the money fails to stop the bleeding, it will ultimately have to be repaid by the state, adding to the sovereign debt load.
And how does Germany think about its role in the global economy? After the much-discussed Economist cover blaming Germany for slowing growth around the world, the business daily Handelsblatt came up with a rebuttal depicting Germany as a boat floating serenely while the world sinks, weighed down by heavy debt. The upshot is that most Germans still refuse to believe they face a vicious reckoning after profiting from their neighbors’ inadequacies.
So Germany and Spain and all the rest continue to jockey for relative advantage, seemingly unaware that their lifeboat is rapidly taking on water. The needier Spain becomes, the less it has to lose from challenging Germany. And the harder it becomes for German politicians to allow themselves to be blackmailed by a negotiating partner so patently weak.
The best illustration of the current state of European play is this Venn diagram from @Pawelmorski. The Spanish bailout, with its conditions, limitations, and likely subordination of private creditors, was acceptable to Germany. Ergo, it probably won’t work.