Bluster and denial over Spain’s bail-out

"Bail-outs in the eurozone used to generate relief rallies that lasted a week," says Nils Pratley in The Guardian. The rescue package for Spain's banks, agreed last weekend, "couldn't even manage a full morning". Spain's IBEX-35 index jumped by 6% on the news but finished Monday marginally down. Ten-year Spanish government bond yields gained almost 0.5% as bond prices were marked down further.

Rescuing the banks

The eurozone has made up to €100bn available for Spain to recapitalise its banks. The exact figure will be determined in late June once an audit of the banking system is complete. The Spanish government has told voters that this isn't a bail-out, as "honour has to be seen to be maintained", says Jeremy Warner in The Daily Telegraph. It's apparently just "the opening of a line of credit" for [Spain's] financial system.

The government's attitude is "emblematic of Spain's approach to its banking crisis, characterised by a mixture of bluster and denial", says The Economist. Europe's rescue funds aren't allowed to inject money directly into banks so the money is going to the Spanish government. The money is a loan that if the entire sum is borrowed would add around 10% to Spain's overall debt burden. "Spain is being forced to borrow from Europe to bail out its banks because markets won't provide the money directly to Spain," says Warner. In effect, it's a rescue that differs little from Europe's bail-outs of Ireland, Portugal and Greece.

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Is €100bn enough?

One reason the markets are sceptical is that Spain has already had to admit that its banks were in bigger trouble than everyone had thought, as the unexpectedly large rescue of Bankia a few weeks ago highlighted. So there's every chance that "the capital requirements of Spanish banks may turn out to be much higher" than €100bn, says Satyajit Das in The Independent.

Bank losses will steadily mount as the economy and the housing bubble deflate further. House prices have slid by 15%-20%, but are forecast to fall by up to 50%-60% in all. Banks could end up needing over €200bn, says Das. Nor will this deal allay fears that Spain will need a general government bail-out too. Given the overriding fear that the banks will bankrupt the government, then if the financial sector needs even more capital, bond yields and hence the cost of borrowing will rise further from already unsustainable levels.

In any case, as this deal adds to the national debt, "potential bond buyers are lending to an even-more indebted country", says Charles Forelle in The Wall Street Journal. Moreover, the basic worry among bondholders that harsh austerity is simply making the debt problem worse by shrinking the economy will endure as the second recession in three years worsens. "The bank bail-out is unlikely to reverse the downward momentum, even if it eases the country's credit crunch," says The Economist.

More trouble to come

Another potential problem this detail has yet to be confirmed is that the deal seems likely to involve private bondholders being subordinated to official ones in the event of a Spanish insolvency. As in the case of the Greek bail-out, this would mean the eurozone being paid before private creditors. But this will make private creditors all the more reluctant to fund the country, as we saw with Greece.

Another possible complication is that the conditions attached to the deal appear to be less onerous than those attached to other bail-outs for the likes of Greece and Portugal. So the other peripheral states could insist on renegotiating their rescue packages, while the anti-austerity vote in Sunday's Greek election may receive a boost. This deal "fits in the fire-fighting category of measures", says Fxpro.com. With the Greek election looming and fears over Italy's solvency growing, it's no wonder markets remain as jittery as ever.