Greek Election Euphoria Proves Short-Lived

by: Acting Man

Spanish Bonds Keep Selling Off, NPLs Continue to Grow

It was a remarkable progression yesterday: from outright euphoria in Asian stock markets to swift disappointment when European markets opened, the Greek election can actually be said not to have helped a whole lot.

Apart from the fact that initial bounces in euro area stock markets ran into selling right from the open, Spanish and Italian government bond yields continued to increase. In Spain's case the 10-year bond yield reached yet another euro era record high:

Click to enlarge

Spain's 10-year yield closes at a new record high of 7.16% (a record since the adoption of the euro).

The selling in Spain's paper was presumably egged on by news that non-performing loans (NPL's) at the country's banks have reached a new record high of €152.74 billion, or 8.72% of all outstanding loans. As reported by the WSJ - and we include a few remarks by Spanish prime minister Rajoy on the Greek election as well for laughs:

"Spanish banks' bad debt data for April provided new evidence of Spain's deepening problems. According to the Spanish central bank, 8.72% of the loans held by banks-or €152.74 billion ($193.1 billion)-were more than three months overdue for repayment in April, up from 8.37% in March.

This was the highest ratio of past-due loans since April 1994 and just slightly below the all-time high hit in February that year, when they rose to 9.15% of the total.

Speaking from Los Cabos, Mexico, Spanish Prime Minister Mariano Rajoy on Monday welcomed the results of this weekend's Greek elections as "good news" for his country and evidence that "the euro project is irreversible." Mr. Rajoy is in Mexico to take part in a G-20 summit.

"The Greek citizens got it right," Mr. Rajoy told reporters.

(emphasis added)

Actually, it is 'no news' at all for Spain. If it were otherwise, its bonds and stocks would not still be under pressure (although we would soon expect to see a correction in yields unless a significant worsening of the fundamental situation becomes evident in the very near future).

However, as to Spain's NPL's, we would like to add something: it is often repeated that as a percentage of all outstanding loans the 1994 crisis was still worse. Now, for one thing, no-one should believe that the current numbers accurately reflect the loan losses at Spain's banks. This is not only due to the fact that they are a very fast moving target, but also due to the fact that Spain's banks have been cooking the books for many years - with the placet of the EU commissioner whose job it would have been to intercede and put a stop to these practices. What is happening now is that they have 'run out of rug to sweep things under' as we have pointed out on several occasions. In short, the 'cookie jar' reserves that were used (inter alia) to hitherto mask their losses are finally gone for good.

An interesting article by Jonathan Weill on the accounting methods of Spain's banks was published last week - we recommend reading it in its entirety, but want to point out the passage about the EU's willful blindness specifically:

"One of the more candid advocates of Spain's approach was Charlie McCreevy, the EU's commissioner for financial services from 2004 to 2010, who previously had been Ireland's finance minister. During an April 2009 meeting of the monitoring board that oversees the International Accounting Standards Board's trustees, McCreevy said he knew Spain's banks were violating the board's rules. This was fine with him, he said.

"They didn't implement IFRS, and our regulations said from the 1st January 2005 all publicly listed companies had to implement IFRS," McCreevy said, according to a transcript of the meeting on the monitoring board's website. "The Spanish regulator did not do that, and he survived this. His banks have survived this crisis better than anybody else to date."

McCreevy, who at the time was the chief enforcer of EU laws affecting banking and markets, went on: "The rules did not allow the dynamic provisioning that the Spanish banks did, and the Spanish banking regulator insisted that they still have the dynamic provisioning. And they did so, but I strictly speaking should have taken action against them."

Why didn't he take action? McCreevy said he was a fan of dynamic provisioning. "Why am I like that? Well, I'm old enough to remember when I was a young student that in my country that I know best, banks weren't allowed to publish their results in detail," he said. "Why? Because we felt if everybody saw the reserves, etc., it would create maybe a run on the banks."

So to sum up this way of thinking: The best system is one that lets banks hide their financial condition from the public. Barring that, it's perfectly acceptable for banks to violate accounting standards, if that's what it takes to navigate a crisis. The proof is that Spain's banks survived the financial meltdown of 2008 better than most others.

Except now we know they didn't. They merely postponed their reckoning, making it inevitably more expensive. Someday maybe the world's leaders will learn that masking losses undermines investor confidence and makes crises worse. We can only hope they don't manage to blow up the whole financial system first."

(emphasis added).

As we often say, you couldn't make this up. There either are rules or there aren't. Since when is it up to EU commissioners to simply make them up on the spot?

Let us briefly return to the NPL's of Spain's banks and the 1994 comparison though. Since people are usually shown a chart of the percentage these NPLs represent of the total loan book, they rarely get to see how the absolute numbers compare. These actually show us the truly breathtaking amount of money supply and credit inflation that has attended Spain's housing bubble. The chart below certainly puts the 1994 situation into proper perspective (chart via Querschü

Spain's NPL's in billions of euros - as a percentage of all loans they are still below the 1994 record high, but evidently the supply of money and credit has gone 'parabolic' since 1994.

This is what happens in a fractionally reserved banking system based on fiat money and relying on an unlimited central bank backstop. This also gives us a rough idea about the staggering amount of capital malinvestment that must have occurred during the boom.

Meanwhile, the IBEX index in Madrid also fell prey to a wave of selling after yet another gap up open refused to hold. Italian bond yields likewise increased once again in sympathy with Spain's - but they failed to make a new high for the move, a tentative sign that a correction in euro area 'problem yields' may be close.

The IBEX in Madrid gapped up at the open and then immediately went south.

Italy's 10-year yield added a few basis points to end at 6.14%.

Lastly, here is a chart we have taken from Germany's 'Der Spiegel' magazine that shows how inadequate the ESM's resources are if it should come to the point where both Spain and Italy require a full scale bailout:

The ESM's size relative to Spain's and Italy's government financing needs between 2012 and 2014. That's actually cutting it very close.

Charts by: BigCharts, querschüsse, StockCharts, Der Spiegel