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Is The Spanish Resolution Just A Weak Compromise?

Finally, Europe made some progress in tackling its financial problems. After an official request by the Spanish government, the finance ministers of the Eurozone countries offered the country a lifeline of 100 billion euro which it can use to stabilize its banks.

Europe throws in money...

For a change a weekend resolution was already reached on Saturday instead of a last-minute Sunday deal. Spain made an official request for assistance early on the day and hours later the finance ministers of the Eurozone threw the country a 100 billion euro lifeline. According to good Eurozone tradition the money will come from European rescue funds such as the ESM and ESFS. These rescue funds have been set up with contribution pledges from all Eurozone countries. So essentially Spain is financing its own bailout, at least partially.

The capital will be used to cover the capital shortfall of the Spanish banking sector which is a complete mess after a decade long real estate boom, bad accounting rules and political influence in many regional cajas. The 100 billion euro should be more than enough to shore up the banks and provide the market with an additional margin of safety.

But what are the guarantees?

The most surprising part of the announcement is the fact that there will be no additional constraints or austerity measures demanded from Europe. The official statements only include the usual comments. "The Eurogroup will closely monitor the progress Spain is making in its attempt to lower the budget deficit and make structural reforms in its economy."

The Spanish Finance minister Guindos noted that the assistance was different from the aid packages of Greece, Ireland and Portugal. Rather than a rescue he described the deal as a loan to Spanish banks under favorable conditions, and it would "alleviate market pressure on Spain."

His boss, Prime Minister Rajoy said just two weeks ago that Spain would not need external aid in order to recapitalise its banks.

Size matters

The final rescue, bailout or aid package, depending how you like to call it of 100 billion euro should be sufficient to cover the worst possible outcomes in the cost of recapitalizing the Spanish banking sector. Last week the IMF estimated that the Spanish banking sector would need 40-60 billion euro in order to shore up its books. However the total costs of the Bankia rescue, the merger result of a range of local cajas, have already run up to 23 billion euro.

Rating agency Fitch estimated that losses could be as high as 100 billion as the sector as a whole had about 180 billion in troubled assets on their balance sheets. The rating agency lowered the sovereign rating for Spain 3 notches on the back of its analysis to BBB, just two notches above the "junk" level. Furthermore, austerity measures would most likely imply that the economy would continue to be in a recession in 2013.

The market needed a decent size package in order to prevent earlier mistakes of too small bailouts, which immediately cast doubt in financial markets. A number below the 100 billion mark would give speculators the chance to test the Eurozone's commtiment to Spain and Italy when markets open on Monday morning.

The agreement would mark Spain as the fourth nation in the Eurozone which would accept a bailout. Portugal has received 78 billion euro, Ireland 85 billion and Greece some 240 billion euro.

Market reaction

Global equity markets have already rallied hard on hopes of a Spanish resolution over the last week. The Spanish IBEX 35 already trades up 10% from its lows and the S&P 500 gained 4% last week. At the same time yields on Spanish 10-year bonds have fallen from 6.7% by the end of May to 6.1% on Friday on hopes of a resolution for Spain.

The fact that no additional austerity measures were demanded from Spain by Europe could indicate that the Eurozone might shift its focus away from austerity towards promoting economic growth, something proposed by French Prime Minister Hollande. Many international economists have also called for promoting growth as a solution rather than imposing solely austerity measures.

However in Europe Germany pays. Either Angela Merkel has softened her stand towards Spain, or politicians are really scared for social unrest in a country with a 24% unemployment rate and youth unemployment being far higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.