Yes, Spain Is Greece

Includes: EWP, FEZ
by: Colin Lokey

Six weeks after the Athens municipality of Acharnes effectively shut down after "running out of money," two thirds of the pharmacies in Spain's Valencia region are closing their doors because the regional government cannot make prescription payments in the amount of 450 million euros. The shut down is a "rolling strike," meaning two out of three of the region's pharmacies will close on a rotating basis until the government pays. Maria Teresa Guardiola, the president of the Valencia College of Pharmacists, told AFP that

"If the banks do not renew their credit for the pharmacies, 500 pharmacies could go bust this very month."

This unfortunate situation highlights how the crisis in Spain is beginning to feed on itself and how desperate the situation is becoming. Regional governments can't make payments to pharmacies for services provided under the nation's public health plan so they appeal to Madrid. Madrid's regional bailout fund, like everything else in Spain, is hopelessly underfunded, so Madrid sells government bonds to Spanish banks to raise cash. Sovereign downgrades cause the value of those bonds to fall so the banks can't extend loans to businesses (like pharmacies) in order to keep them open when regional governments can't make payments.

According to ThinkSpain, Valencia has been able to use some of its regional bailout money to pay portions of long overdue balances with the pharmacies. However, because new debt is added each month and because the pool of money from Madrid's regional bailout fund is finite, it is a mathematical certainty that the balance will not be paid in full anytime soon. This suggests that drugs may become hard to come by in the region should financial constraints force some pharmacies to close permanently.

On the bright side, pharmacies may find Spain's banks in better spirits now that it appears they will not be forced to cough up billions in cash to cover haircuts on T-Bills to which collateral rules were misapplied. Last weekend, a German newspaper accused the ECB of not following its own rules in evaluating the quality of some of the Spanish T-Bills pledged by Spain's banks as collateral for ECB loans. According to Die Welt, the oversight caused the ECB to make some 16 billion euros in loans it shouldn't have to the Spanish banking sector. According to ECB Vice President Vitor Constancio, however,

"...the whole question had no practical implications whatsoever and no costs or losses to anyone."

Of course this assumes there was ever "a question" in the first place and in the Bank of Spain's eyes, there wasn't.

You see, the Bank of Spain wasn't concerned with the ratings assigned by Moody's and S&P when it applied the discount to the T-Bills. It was going by the rating assigned to Spain by Canadian-based DBRS who still has the country at "A low." Now this would be peculiar if you didn't know who was in charge of sovereign ratings at DBRS. As it turns out, the head of sovereign ratings is a Fergus McCormick who, less than one year before signing on at DBRS, was a VP at BBVA, the second largest bank in Spain. It would certainly appear that the potential exists for a conflict of interest.

Ultimately, this brief discussion highlights the extent to which the domino effect has already toppled Spain. The Bank of Spain and the ECB are now referencing obscure Canadian ratings agencies whose employees used to work for one of Spain's largest banks in order to justify the acceptance of Spanish T-Bills as collateral. Meanwhile, vital services are being suspended in Spain's bankrupt regions. So the next time someone tells you "Spain isn't Greece," ask them if they've tried to fill a prescription in Valencia lately. While you're at it, tell them to go short European equities (NYSEARCA:FEZ) or, better yet, short periphery bonds -- it's getting harder to bail the water out of the leaky boat.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.