16th May 2012
One of the ironies of the crisis which has engulfed the Euro is that summits which are presented as solutions to the crisis in fact have become triggers for it getting worse! Unfortunately Europe's leaders have not figured out this basic fact yet and have given us another example of inflation by increasing the number of summits. The latest which has already been christened Homer was between the new President of France Monsieur Hollande and the German Chancellor Angela Merkel and yes it has had the same effect. Government bond yields in the peripheral Euro nations are falling and we may yet see a crossover in two of the main Euro exchange rates as the US Dollar strengthens into the 1.26s and the UK pound rises into the mid 1.25s.
Spain is being hit hard
Ironically much of the impact is happening in Spain and she was not even present! Indeed this morning her Prime Minister Mr.Rajoy has said that she faces the danger of "astronomical" borrowing costs as her government bonds continue their recent price falls. Her ten-year bond yield has nudged above 6.5% today but in volatile trading has then retreated to 6.4%. Actually she can afford to sustain neither rate for any great period of time particularly as the financial world has been reminded both of the weakness of her banking system and the weakness of Spain's response to it.
Spain's equity market is also taking a pounding and is down a further 1% as I type this with the Ibex 35 index at 6610. If we look for some perspective we see that it was at 10,226 a year ago and that the main fall has come since mid-March of this year where it was just below 8600 for an approximately 22% fall in two months. Something of a chill for Spanish equity investors and pension funds and of course pension funds are taking losses too in their government bond holdings in what must be a grim period for them.
Spain's banks are leading the falls with my subject of last Tuesday Bankia (2.26 Euros then) being 9% down today alone at 1.66 Euros.
Why are Spain's banks being hit again?
I have discussed the underlying problem of Spain's housing boom and bust being accompanied by a bust in Spain's banks which the Spanish authorities have done their best to ignore. El Commercial has summed it up thus below and the emphasis is theirs.
"In 2008 we were told that the maximum exposure to troubled real estate loans of the banking system in Spain was €25 billion. Today, four years later, the figure many of us had in mind is now official. Nearly €184 billion in troubled non-performing loans."
Indeed El Commercial points out a particular Spanish issue.
"no less than €73 billion of the total €184 billion in toxic loans correspond to "land". This is important because one of the things that separates Spain's real estate bubble from others in the OECD is that some banks and cajas (savings banks) had the brilliant idea of giving loans to land before urbanization. This has to be completely written-off."
And we get an estimate of the scale of the problem for Spain.
"between 20% and 40% of GDP"
The Official Response
Last week Spain's government admitted to some of the problems but the response repeated past mistakes. For example she proposed merging four cajas or savings banks to create a "stronger" one. This is a policy I have criticised since the beginning on the lines of "bad money drives out good" since the beginning but now we have the evidence of what has happened at Bankia which was the result of merging 7 cajas.
Such plans also involve what is considered to be "high finance" and step forward some 30 billion Euros of what are called Co-Cos or convertible bonds to help clean up the mess.This has two main problems firstly the use of "high finance" in Ireland combined with denials of the underlying problem made things worse and not better. Secondly 30 billion Euros is nowhere near enough to cope with a banking system dealing with a housing market which is still falling.
What about lending to the rest of the economy?
Whilst Spain's banks are in such disarray how much lending will they be making to her economy? I think we know the answer to that and she will suffer because of it. This is one of the strongest arguments for my suggestion that we needed to fully clean up the banking sectors affected by the credit crunch as "zombie" banks affect the economy in a drip-drip manner in subsequent years just like they did in Japan's lost decade.
If we look at credit to Spain's smaller and medium sized businesses ( one million Euros and under) we see that it is still falling.
What is happening in her economy?
The Service sector
As the largest part of any modern economy such numbers are eagerly awaited as a signal and her are the numbers from Spain's statistics agency.
"The interannual rate of turnover for the Market services sector stands at -5.3% in March, more than three points below that registered in February."
Ouch! That is quite a rate of decline and when we recall Spain's already high rate of unemployment (24.4%) we see that it comes with an unpleasant chaser too.
"Employed personnel decreases 2.3%, as compared with March 2011"
If we look for deeper analysis of this we see that the underlying index is now at 93.5 where 2005=100.
And her industry?
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