Advancing a Free Society

Spain at the Precipice

Sunday, April 15, 2012

Tuesday of this week the government of Spain must return to financial markets to auction 12- and 18-month treasury bills.  Thursday the Spanish government will float two- and ten-year bonds.  While the specific amounts are not yet announced, the government has only financed half of its 2012 debt needs.

Just released Bank of Spain data shows that Spain accounts for 28% of all European Central Bank lending since December, when the ECB set about injecting a tidal wave of liquidity into the seizing European banking sector.  Spain has soaked up $316 billion of the roughly $1 trillion the ECB pumped into Europe in the past six months.  Despite even that injection of capital, Spanish borrowing costs are once again what they were before the ECB effort, and the pace at which banks are resorting to the ECB has tripled since November.

The political maneuver decided on by the ECB -- to offer cheap loans that banks could use to purchase government debt (shielding government from markets) -- was necessitated by the EU treaty’s prohibition on the Bank loaning money directly to governments.  And the triangulation has actually worked.  But the European Central Bank has concluded its priming of the pump and has neither plans nor money in its bail out funds to revisit that decision.  Nor would Spain meet the EU bail-out criteria, having just announced it is increasing its deficit projections for the year beyond that agreed with the EU.

The bank data reveal that markets have deserted both Spanish government securities and Spanish banks.  Banks could not raise cash in the market; government bonds were not being bought other than by Spanish banks.  It also means the ECB has huge exposure to a Spanish default -- virtually guaranteeing that the European Union will need to bail Spain out, if only to prevent the ECB from crashing when Spain falls.

If Spain should fail to meet its capital requirements on Tuesday and Thursday, it could easily trigger a flight from Spanish banks, government intervention to prevent their collapse, and then necessarily an EU bailout of Spain to keep the ECB from being dragged down by a Spanish default.