Portugal´s bail out; Spain´s, the next. It´s the politics, stupid

Portugal has fallen in a vacuüm: The government has dismissed, admitting he was incapable of negotiating an intervention of the EFSF – the European Facility that has rescued Ireland & Greece.

“Until new elections, this government has neither the legitimacy nor the power to negotiate any agreement at all,” said Fernando Teixeira do Santos, finance minister.

That means the government has ruled out the possibility of Portugal asking for a bail-out for almost three months, in spite of doubts that it will be able to meet €9.3bn ($13.2bn) in bond repayments that fall due in April and June. (FT today)

The chain of fatal events in Portugal could be replied easily in Spain. The main problem is not economic, but of government capacity. In may, there will be regional election in Spain, probably winded by the opposition; the result of which will be a more flawed government, more unveiled regional debt, awful financial conditions, and a general lack of decision of both party to face the real problems.

The main problem for Spain is the recapitalisation of flawed banks. That could be done with some difficulties, but probably it will be well-assumed by the market only  if  government has sufficient will. Spain has not so high public debt, and to put € 40 billion will not mean a huge problem. All in all, the total debt rise from 60% to 80% of GDP, more or less the media of euro zone.

But nor te government party, neither the opposition, has the intention to joint its forces to do it. Each one is not capable of facing it; but the huge distance between them, and the good perspective of the opposition to wind election next year, has awoke the wild impiety of liquidating entirely the  socialist (a reasonable target in normal times, but not today).

The probable result of all that will be a profound wear of socialist party, and a no less haunting possibility of a right party managing a  very unpleasant and useless bail out, which perversity can be observed in graph: The countries rescued has not been capable to get some credibility.

What Nomura said of Spain

Nomura has done a well analysis on the crisis of euro, reaching the conclusion that “Euro will work”. Here, a summary of its ideas about Spain. In the graph, All you need to know!

Spanish banks  must raise about € 40-80 mm (in the best scenario) to recapitalize.  In Nomura´s opinion, it could be done,  if government  gear well its debt. As you can see in the graph, the public debt is rising to about a 80% GDP level, if we include the  40-80 mm funds of recapitalization (20% of GDP).

After that,  Government should cut the primary balance to a 2,5% of GDP,  until 2012. Since then, it must gear a primary excess of 3% until 2020, to return to the “original” debt rate/GDP of 60%.

The exercise is quite clear, BUT: the problem is to perform a vigorous growth rate that Nomura doesn´t explicit from where it would raise.

The big problem, as I´ve said in other occasions, is the monetary policy. Monetary policy is in the hand of ECB, and it is not designed to the sake of Spain.  It has worked well while Germany was stagnated – because the Unification. But now, the countries like Germany Finland and others, would like a more restrictive  monetary policy – that Trichet is about to carry out.

I´m affraid Spain (nor Portugal, Ireland, Greece) will not have its chance to get out of the hole.

Spain downgraded

Moody´s has downgraded  the debt of  Spain, to Aa2. The main reason is that Moody´s estimate the cost of restructuring saving banks in 120 mm € (in extreme cases), not the official 20 mm.

The effect in the markets has been instantaneous, as it can see in the graph, which plot the 10 years yield of Portugal´s bond. So, we return to a pre-crisis level of concern. The ECB has been forced  to intervene buying bonds to sustain its prices (see the up and down in the graph). bad news for Spain are worse news to Portugal. A very bad sign of sensibility in the markets.

In any case, Spanish bonds have fallen also, recovering their risk premia of crisis times. Meanwhile, “Spain shoot the messenger” (ALPAHVILLE, FT)




Euro in 2011

What to expect for te euro zone next year?

In Wolfgang Münchau article (http://www.ft.com/cms/s/0/275f7a42-1386-11e0-a367-00144feabdc0.html#axzz19aESlgPH) you can get an excellent perspective of the possible eventuality for the European Money.

Summing up, what we have is that the survival of the euro will mean a lot of misery.  Why? because the best condition of financing sovereign debt will be  quite impoverishing. That is because interest rate would be higher than NGDP growth which will crowd out resources to create jobs. If interest rate of the debt is higher than NGDP growth, th ratio Debt/NGDP is susceptible of exploding.

So how many time we must expect a trend of misery, high unnemployment, and low life level to save the euro?

I´d like to point out some Münchau´s paragraph:

1) The eurozone survived 2010. My prediction is that it will survive in 2011. The question is, in what condition?

2) Most of the countries in the periphery suffer from a competitiveness problem – which is what makes this crisis so toxic. If you reform your labour markets and deflate your wages to become more competitive, inflation falls, and so may house prices. The real value of your debt explodes and you might end up insolvent. Combined debt and competitiveness problems are very hard to resolve without devaluation or inflation. It is not a matter of discipline. Infinite discipline could still make you insolvent.

3) The European financial stability facility (EFSF) is lending money to Ireland at an interest rate of about 6 per cent, which is higher than the country’s nominal growth rate is likely to be for many years. While the loan solves Ireland’s funding problems, it actually exacerbates the country’s underlying solvency problem. The Irish situation reminds me of one of these loan shark advertisements: “Need money fast? No questions asked.”

4) Spain should be solvent, but of course there always exists an interest rate/growth rate combination at which the solvency assumption breaks down. With 10-year yields no higher than 5.5 per cent, the approximate current level, I would expect Spain to go through a severe and long recession, possibly with further asset price falls. Productivity will probably remain low and unemployment high for the foreseeable future. But the country should remain solvent – miserable but solvent. If interest rates were to rise to over 6 or 7 per cent, perceptions of Spanish solvency may change.

5) All existing bondholders will be protected until 2013. All government bonds issued from 2013 onwards will have collective action clauses. This means that if a government cannot service the debt, it can agree a haircut with a majority of investors – with legal force for all investors, including those who disagree with the majority vote. Looking at it from a risk-management perspective, this means that the entire default risk of the eurozone periphery will be concentrated on post-2013 bond issues. No one in their right mind would buy such junk bonds.

6) The way the new crisis mechanism is constructed ensures that the market for European periphery bonds is going to remain thin. What is now being conceived as a new crisis mechanism may end up as the eurozone’s principal funding agency if no one else will provide the funds. It would issue its own bonds – eurozone bonds – underwritten by the few remaining triple A-rated sovereigns, most importantly Germany and France. It is hard to see how such a construction could be sustainable. Should there ever be a default, Berlin and Paris would have to pay up – or default themselves.

This year, Europe’s political leaders pledged to do “whatever it takes” to save the euro. They never answered the question of what that meant. My central prediction for 2011 and beyond is that we will find out.

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