Thursday, 13 January 2011

Euro Debt

This week has been the first week of the new year that Eurozone economies have gone to the Bond Markets. They seem to have dodged a bullet for now.
Earlier in the week, Portugal, thought to be the next country in the sights of the markets for a bail-out, managed to find buyers for its Bonds, and on its Ten Year Bond maturing in 2020, it managed to sell it with a slightly reduced Yield, 6.716 percent from 6.806 percent in the previous sale in November. The October 2014 bond yielded 5.396 percent, up from 4.041 percent in October's auction.

But, in the weeks preceding these auctions, the ECB had been intervening considerably in an attempt to ensure that the Portuguese debt auction was succesful. One reason for that was the fact, that a much larger Spanish and Italian auction was due just days later. The Portuguese auction was quite small compared with the funding that Spain and Italy need to raise.
The ECB has been buying Bonds in the market for some time, and we do not know how much of the success of the Portuguese auction was due to the ECB buying the debt, by one means or another. But, given the level of intervention to ensure its success, the slightly reduced yield on the ten year from 6.8 to 6.7, is hardly stellar. Moreover, the increase in yield from 4 to almost 5.5% on the 2014 Bond represents an increase of more than 25%!

Its thought that any rate over 7% is crucial, because over this level interest charges become so significant as to make it almost impossible to finance debt out of income. It had been feared that the Yield might have gone over 7%, but even at 6.7%, the interest burden on Portugal is considerable given that it has been hardly growing for the last decade, and the austerity measures introduced by the Government, far from improving that situation are sending its economy back into recession.

In fact, Portugal's problems contrast with those of Spain. Portugal did not run up a massive deficit as other countries did. Its problems arise not from accumulated debt, but from a stagnant economy, unable to cover the debt it does have. Although, Spain, as a much larger economy than Portugal, has some advantages, and its economy grew rapidly over the last ten years or so, in some ways its problems are greater. A large part of the growth it enjoyed was based on a bubble in its property market, which sparked a boom in its construction industry. The property market is no longer bubbling up, and with 1 million empty houses, its cosntruction industry come to a grinding halt, and is one reason that Spain's unemployment rate is at depression levels of 20%, and youth unemployment of 40%.

In an interview with CNBC, Spanish Finance Minister,Elena Salgado, said,

" “We are confident on them because as you know we have gone through a big strong restructuring process, we have gone from forty-five savings banks to seventeen and of course we have gone through a stress test, very tough stress tests I have to say,”,

but, of course, these are the same stress tests that irish Banks passed last year, the same Irish Banks that have now essentially collapsed, and been taken over by the Irish State. She went on,

“Transparency is going to increase because at the end of this month all savings banks are going to say what assets they have,”

“I think you have always to consider the level of our non-performing loans in Spain is very low. The mortgages are paid differently than in other countries, you respond not only with the house but with all the properties you have so this is one of the reasons of course that the level of non-performing loans is very low,"

But, this is reminiscent to the delusions that were perpetrated with the sub-prime crisis. The reality is that although the property bubble has ended in Spain, and there have been some reductions in prices, those reductions do not in anyway reflect the dire state of the economy or the property market. In fact, there is an incentive for the Banks and other finance houses to perpetuate fictional valuations of the property on their books, so long as they can use it to provide a pretence of economic strength, and thereby to continue drawing money from the ECB's funding arrangements. But, sooner or later, the dam will burst on that, and the pretence will collapse. When it does, there will be a rush to get rid of that 1 million empty properties at almost any price, and the assets on the Spanish Banks' books will no longer look very safe. That may not affect the big Spanish Banks like Santander, which operate on a global basis, and have very profitable operations in Latin America, but many of those small cajas that have provided the loans for the property bubble, and which the Spanish government is trying to shore up with mergers and other measures, will be seen to need massive recapitalisation.
That is likely to be on a scale much greater than the recapitalisation of the Irish Banks, and the question is, at a time when the Spanish State is itself facing increasing questions about how it can sustain its own sovereign debt, where will that recapitalisation come from? Its possible that the big Spanish Banks might step in, but the experience of the Finanical Meltdown, shows how easy it is for even solid banks to land themselves in big trouble by taking on the unknown debts of others.

In the meantime, the actions of the European political leaders resemble the moving of deckchairs on the Titanic, as they continue to combine attempts to deny the severity of the crisis with continued wrangling and attempts to obtain political advantage as the price of agreeing to any measure that might actually provide a longer-term solution.

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