Monday, June 11, 2012

Spain's bailout for dummies

What's gone wrong?  A cluster of Spanish banks loaned money during the credit boom years of low interest rates in the Eurozone to a large number of investors whose investments have now proven to be worth far less than the loans.  Most of this is the property bubble in Spain which has popped, with property values dropping by 30-50% in some places.  The banks are facing insolvency because if they write off the bad loans they will fold.

It is not a sovereign debt crisis of the kind being witnessed in Greece.  In fact Spain's total national public debt as a proportion of GDP is less than Germany's (although it has had a serious budget deficit issue risking escalation of that debt) at 68.5%, although it was predicted to hit 78% at the end of this year.

Whose fault is it?  It takes three to tango this one.  None of these loans would be taken out if people or businesses hadn't borrowed to "invest" in the Spanish property bubble.  Nobody forced them to do this, so they bear responsibility for their own personal tragedy of poor choices and being lumbered with liabilities.  Of course, they wouldn't have received such loans if the banks had been more prudent about their predictions about the property market and had considered the risks of an inflated property bubble.  So the banks bear responsibility for lending money in circumstances that were overly optimistic.  Finally, the European Central Bank sets the interest rates for banks accessing its fiat currency.  As interest rates were set based predominantly on the dominant economic drivers in the Eurozone of Germany and France, this effectively created a line of cheap credit out of nothing at all.   Of course, since the European Central Bank makes money from thin air, it doesn't really bear any consequences of anything, as it is those who own and loan the currency that bear those consequences.

Why should governments get involved?  They shouldn't.  The banks should go bust.  Their shareholders and creditors should bear the losses.  At the most, if there is a deposit insurance scheme, then depositors up to a certain level should be protected, but there is no good reason for governments to do anything other than to have a framework within which bankrupt banks can wind down.   Of course, regional Spanish governments own a majority of the largest bank being bailed out - Bankia - which indicates that it going bankrupt means that those governments lose their "investments".   Naturally, none of them are very keen on this because they want their own decisions to be vindicated.

Why doesn't the Spanish government do it?  It can't afford to do so.  Whilst its relatively new government is eagerly cutting spending (and increasing taxes) to cut the rampant overspending of past governments, it is finding that interests rates on newly issued sovereign debt lie over 6%.   If it was to try to swallow the bankrupt banks it would see its debt as a proportion of GDP slide up by another 9% of GDP bringin it close to 90% (and 100% in 2-3 years' time).  It doesn't want to do that, and claims that Eurozone countries are like a big cozy club that look after one another (although German, Dutch, Austrian, Slovak and Estonian taxpayers might have a wry laugh at how one way that relationship is).

Where is the money coming from for this bailout?  Thin air.  It is part of the slow fiat currency issuing of the Eurozone called the European Financial Stability Fund, which is to become the European Stability Mechanism.   In both cases, they can only lend money to governments, so the Spanish Government will be effectively borrowing from its Eurozone supporters, adding to its public debt, pass on the money to the banks (presumably in the form of capital) and the banks will then pass on that money to the European Central Bank to provide liquidity in the face of their bad debts.  Of course don't think that making money out of thin air and passing it through a merry-go-round has no cost.

Who will pay?  Taxpayers directly in the solvent Eurozone countries (i.e. excluding the PIIGS) and all Euro currency holders indirectly, as they contributed involuntarily to a fund to socialise the losses of the banks.  Spanish taxpayers will be expected to pay too, as they guarantee the repayment of the "credit line", so ultimately will have to pay more unless miraculously the bailed out banks can be sold for more than the bailout funds.  Of course, given Spain's precarious budget deficit, public debt and national economic position, the real risk is that it lays the path for Spain to follow Greece - and so demand more money from Eurozone taxpayers.

Who will win? Creditors of the bailed banks (even if they face major writedowns in their shareholdings).  Owners of Euro debt in Spain.

Who will lose?  Taxpayers across the Eurozone, who collectively will see more of their future earnings diverted to save bad investments.  Ultimately this means the Eurozone economy being dragged down a small notch, again, for many years.  Holders of Euro currency deposits or cash lose as well, because it ultimately contributes to inflation.

What happens next? The markets will lemming like treat all of the propaganda around this bailout as gospel, and get a sudden shot of confidence, until the realise it helps to inflame a sovereign debt crisis in Spain.  The Eurozone economies will be no more better off.  Economic growth will not be facilitated.  The lunatic far-left parties in Greece (including the fascists) will clamour that Greece should get the same support, as will Irish politicians and those in other profligate Eurozone countries.  None will acknowledge that this is not about sovereign debt and actually increases Spain's sovereign debt.  People in France will have voted for a socialist Parliament, which will seek to continue the "print it and bail them out" philosophy that pretends that fiat currencies can be used to just print your way out of recession.  The ideological debate in Europe will continue between three groups:
Austerity and Integration:  Led by Germany, it is the view that things will get better if only the PIIGS would follow the policies of the 5 or so Eurozone countries that have budget deficits lower than GDP growth, improve competitiveness and then create a new European Treaty that harmonises budgetary, taxation and economic policies. Spain's current government has tended to share this view too.
Profligacy and Integration:  Now led by France, but also driven by leftwing and populist politicians in the Eurozone.  It is the view that the Eurozone should socialise its gains and losses.  In other words, Germany and others should pay for the debts and deficits of the PIIGS, and there should be extensive transfers across the Eurozone, as if it was a United States of Europe.  
Disintegration:  A growing view that the Euro is unsustainable in its present form, and the way to resolve the crisis is for it to split into two zones or multiple independent currencies, so that the PIIGS can devalue their way to "competitiveness", and the European project becomes a looser free trade association and customs union.  This is the view of Eurosceptics generally, although there are versions of this argument against any form of open Europe (from Marxists and fascists) or against new small fiat currencies (supporters of commodity-based currencies).

The one thing is sure, don't expects sun to rise and everything to be rosy.  For the Greeks have to vote again to decide if they want to swallow reality and take their medicine, or run away from it and truly see what it takes to become a tinpot backwater that makes Albania look good.

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