The pain in Spain
- 19 April 2012
The auction saw a small increase in borrowing costs, but at 5.7% remained below the all-important 6% level. Equally, the bond offer was over-subscribed: Rate strategist at Rabobank Richard McGuire said on the results: "A reasonable set of results, which will go some way to allaying fears the domestic bid for Spanish bonds has dried up. That said, as evidenced by the accepted yield on the 10-year, this support does come at a price."
There were a number of reasons why this auction was so important, but perhaps the most significant was the involvement of the under-pressure Spanish banks: "Financial media and investors are going nuts over this auction …because of the maturity of debt Spain is selling…Spain has issued far more short-term debt than long-term debt, pandering to the cheap cash banks have because of the European Central Bank's two three-year long-term refinancing operations.
"Thus, Spain's ability to sell 2.5-year securities that mature before the LTRO expires will be vital to how well Spain can weather the storm around its banks. Poor results on the 2.5-year auction would signal that investors are already ignoring the positive impact of the LTRO, and that Spain's sovereign debt situation is about to get a whole lot worse."
This is a theme picked up by Shaun Richards in his blog: "Spain's banks have also been gorging on her government's debt. The latest figures show that they now hold some 220 billion Euros of it as opposed to 156 billion Euros a year before. As these figures are only up to the end of January we only have the impact of the first LTRO from the ECB but it seems to have led to an increase in holdings of about 40 billion Euros….
"There is a very dangerous loop here which we saw in Greece. Central Banks give cheap money to banks, they use it to buy sovereign bonds, if the sovereign hits trouble it then also has to bail out the banks holding its bonds! Via this route the benefit of the debt restructuring recently undertaken by Greece was reduced considerably."
But there are plenty who believe that Eurozone policymakers will not let Spain fail. Schroders' Gareth Isaac, for example, has taken a small position in Spanish government bonds on that basis. The manager of the newly-launched Schroder Strategic Bond fund says:
"Spanish bonds at over 6% is a worry, because the debt would become unsustainable…But I bought into Spanish bonds this week. Spanish is one of the largest countries in the world. If Spain was allowed to go like Italy in the fourth quarter of last year, the consequences would be very severe. Spain is making the structural changes to its economy in areas such as labour laws and I believe it will be rewarded by the ECB. Lehmans showed the consequences of a bank failure, for an entire country, the consequences would be devastating. I simply can't see it going the same way as Greece."
He said the fierce austerity measures in Spain's budget and an increase in its deficit, combined with unemployment running at over 20%, have colluded to spook markets. "However, Spain is making the necessary structural reforms, and it is too large and too ingrained in the European project not to sort itself out," he said.
But, for the time being at least, the situation continues to look dire. This auction has not addressed Spain's long-term problems.
"Firstly, Spain did borrow a lot of money during the good times. Actually, it borrowed a hell of a lot of money and sprayed it away on projects that provided little long term benefit. Secondly, the state and, in particular, the municipalities and towns' expenditure created an increase in property prices which Spanish investors were keen to jump on the back of. They borrowed hand over fist from Spanish banks to invest in an inflating property bubble which has of course burst. Most properties were never finished and the Spanish countryside is scarred by so-called ciudades fantasmas: ghost towns.
"Much like everywhere in the western world, Spain is struggling for growth and is in the grip of a crippling unemployment issue. Spanish youth unemployment, people between the ages of 18-25, is now within a short hop of 50% while factories and shops lie empty as consumers keep their hands very much in their pockets."
The recent budget imposed a new round of substantial austerity measures that have led to civil unrest in the country. It is too early to judge their success or otherwise, but many still believe that Spain is heading for, at best, a prolonged recession or even a depression. The successful auction averts a crisis temporarily, but the pain in Spain continues.
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