What does the latest Spanish bail-out mean? Buy Europe

The latest bail-out for Spain suggests that, while the single currency may not have a long-term future, the euro-crisis will stagger on for quite a while yet. And that will throw up opportunities in Europe for investors, says John Stepek.

That didn't last long.

The traditional burst of market euphoria that normally follows eurozone summits has worn off already.

The European Union might have thought it had seen off disaster. Spain was meant to be having its banks bailed out directly. And there was the prospect of the European bail-out fund buying sovereign debt too.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

And yet Spanish bond yields soon ran back up to around the 7% mark. So there's been another emergency discussion session which ended this morning.

So here's the big question: is another eurozone disaster looming?

The answer might surprise you...

The Spanish economy doesn't look pretty

Spain's in a mess. It costs the country around 7% a year to borrow over ten years. It costs more than 5% to borrow over two years. It has rampant unemployment, and the fallout from its property bubble has left its banking sector with huge potential bad debts.

Spain's big problem is not public spending as such. It's that the government can't afford to prop up its banking sector. They might be too big to fail', but they're also too big to save' for Spain alone at least.

The big breakthrough at the EU summit was the idea that the eurozone bail-out fund would recapitalise the banks directly. By bypassing the Spanish government, Spain's sovereign debt burden would remain manageable.

It would also avoid the problem of eurozone bail-out loans taking precedence over any other lenders. So lenders to Spain needn't fear being stiffed in the same way that lenders to Greece were.

Of course, it's one thing to say that the bail-out fund would recapitalise banks directly. Making it happen is quite another thing. And after the initial summit, it all started to get a bit blurry.

For a start, the Finns and the Dutch weren't keen. They argued that "Madrid would still in some form be liable for the €100bn of loans on offer for Spain's banks", as the FT notes.

Over and above that, this direct recapitalisation can't happen until there's a pan-European banking supervisor. In other words, there needs to be one regulator to rule them all.

Why's that? Mainly because if the crisis has taught us one thing, it's that national regulators tend to be a bit soft on their banking sectors. (That lesson extends beyond the eurozone, clearly). If the whole eurozone is agreeing to take on liability for a national banking sector, they want to be sure that it's a tough Europe-wide regulator who's setting the rules, not a compromised national one.

So they've had another meeting this morning to try to iron some of this stuff out.

They've now agreed that Spain will get an emergency €30bn by the end of this month (assuming that the various governments agree).

While the Spanish government will be liable in the first instance, eventually once the Europe-wide supervisor exists the loans will be converted into direct cash injections into the banks.

Of course, given how long things take in Europe, and the hostility of various parts of the eurozone to the idea of shared liabilities, a single banking supervisor could be a long time coming.

Meanwhile, Spain has also been given more time to get its debt-to-GDP ratio down. In other words, it won't have to be as ambitious with its austerity measures.

The European project looks set to trundle on

So where does that leave Spain in the meantime? Will this be yet another short-lived sticking plaster bail-out? Probably.

But the key is, there'll be another sticking plaster after that, and then another after that. For all the talk of bond yields breaching 7%, it's important to understand that Spain is not Greece. Greece hit the point where it was in danger of genuinely running out of money, and having trouble paying for public services.

As the FT points out this morning, Spain can "in theory, keep refinancing its debt at current prices for some time, particularly if it mainly sells more short-term bills and bonds, yields on which are still substantially lower than they were during last autumn's turmoil".

And most Spanish mortgages are pegged to the Euribor (the European version of Libor yes, it was fiddled too, in case you're wondering). In other words, rising Spanish bond yields don't really impact on borrowing costs for households.

Hans Lorenzen of Citigroup tells the FT that rising borrowing costs would likely make Spanish banks crack down harder on lending. But I suspect that credit is already so tight and demand so low that it makes little difference.

The point is, Europe has shown that it's not willing to let Spain go. That suggests that it will continue to do what it takes to save it. And there's enough breathing space available to let the slow-but-sure process continue to roll on.

Yes, Greece may well throw another spanner in the works in the future. But the more time the eurozone buys to circle the wagons, the less important Greece becomes.

In short, while I'm not convinced the euro has a long-term future, I think it'll stagger on for a while longer. Of course, it'll probably be weaker. That's what you'd expect if the whole zone agrees to share liabilities. But this could also be good news, certainly for Germany, which is ultimately the backbone of the region.

This is one reason why we're becoming increasingly interested in battered-down European stocks. The other reason is that they're cheap. And the best way to make money in the long run, is to buy stuff when it's cheap. You can read more in our recent MoneyWeek magazine cover story on Italy: Why it's time to pile into Italian stocks. And for other ideas on eurozone stocks to buy, read our recent Roundtable here: The 17 investments our experts would buy now. (If you're not already a subscriber, subscribe to MoneyWeek magazine.)

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

Britain's banks: this time it really is different

Many people think bank share prices will recover in time as the financial crisis abates and the economy recovers. But Merryn Somerset Webb disagrees. There will be no 'reversion to the mean' for them, she says.

Will Malaysia succumb to the 'curse' of Battersea power station?

Every attempt to develop Battersea power station has failed and the developers have seen their home economy collapse too. So does its purchase by a Far-Eastern consortium mean you should now short Malaysia?

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.