How Spain's banks could be the Northern Rock of Europe

published 29 January 2008

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I like to keep an eye on Spainat the moment. It's a bit of a morbid fascination.

The economy is in the same or worse trouble than the US and the UK, but it has no central bank to fall back on to bail it out, and it can't devalue its way out of trouble as the US is trying to do.

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So what will it do? And what will happen to the eurozone when Spaindoes finally crack under the pressure? Who will bail it out?

Well, interestingly enough, it seems that Spain's banking system is already being propped up by the European taxpayer, in much the same way as Northern Rock is being propped up by us British taxpayers.

The Europeans just don't know about it yet

Spainmight be unable to set its own interest rates, but it does appear that its banking system is being propped up very generously by the European Central Bank, as Ambrose Evans-Pritchard points out in today's Telegraph.

The secret bail-out of Spain's banks

Spanish banks issued a record £39bn of mortgage bonds and other asset-backed securities in the fourth quarter, according to ratings agency Moody's. Now, as you'll no doubt recall, the market for these securities seized up back in July and hasn't really opened up since.

(Incidentally, that's one of the reasons why mortgage rates in the UKaren't really coming down, despite the fall in the interbank lending rate and the base rate. The banks and building societies still can't sell on the loans they make.)

So who is buying all these Spanish mortgages? Well, it seems they are being used as collateral for loans from the European Central Bank. The ECB accepts AAA-rated securities as collateral, apparently unaware that the label AAA carries a lot less weight than it used to.

This has helped Spanish banks avoid the fate of Northern Rock. The Rock, you'll no doubt remember, was brought down when it was unable to sell on its mortgages, which meant it was unable to pay back the money it had borrowed to write them in the first place. It seems that Spain's banks, rather than get a very public loan from the ECB, have instead been quietly dumping their mortgage books onto it.

Of course, no one's overtly admitting to this. And at the moment, the consequences of all this aren't entirely clear. But if the ECB is holding a lot of mortgages as collateral against loans to Spanish banks, and the Spanish property market crashes as badly as say, the US, you do have to wonder just how much of that money the ECB is going to get back. How will German taxpayers feel about bailing out the Spanish? I don't know. But I can't wait to find out.

How the Fed will keep propping up the gold price

Gold hit another fresh record yesterday, while platinum and silver hit new highs too, a 27-year one in silver's case. Power shortages in South Africahave shut down mines in what until recently was the biggest gold producer in the world (last month we learned the biggest is now China).

I'm sure our commodities writer Dominic Frisby will have more to say on gold in Money Morning later this week, but suffice to say, that while South Africaseems to have provided a nice little catalyst to propel gold even higher, it's not the core reason that the yellow metal is climbing.

The Federal Reserve meets tonight to discuss interest rates again and it looks like anything less than a half-point cut will disappoint the thin skins on Wall Street. And we all know there's nothing the Fed cares about more than making sure the boys on the Street are kept happy.

A drastic cut looks even more likely after yesterday's dreadful housing data. New home sales fell to a 12-year low in December again showing that there will be no bottoming out in this market for a long time to come.

So the Fed has all the excuses it needs to happily keep undermining the dollar and destroying the savings of those few UScitizens who actually have any. A half-point cut tonight would take the key Federal funds rate down to 3.0%. Headline inflation grew at an annual rate of more than 4% in December. The message is pretty plain saving must be punished. Get out there and spend.

Under those circumstances, anyone who wants to have a hope of preserving the value of their money has to find somewhere other than cash. And many are turning to gold, in its age-old function as reliable money. You can read more about how to invest in gold in our Investing in gold area.

Turning to the wider markets

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Housebuilders weigh on FTSE

In London, the blue-chip FTSE 100 index ended yesterday 80 points in the red, at 5,788, although off an intra-day low of 5,788. Miners including Anglo American were sold off as the copper price - which has sustained gains in the sector over recent days - fell for the first time in four days in Shanghai. However, it was housebuilders, most notably Taylor Wimpey and Persimmon, who dominated the fallers in light of the latest evidence from Hometrack of falling UKhouse prices. For a full market report, see: London market close

On the Continent, the Paris CAC-40 ended the day 29 points lower, at 4,848, as SocGen extended falls. In Frankfurt, however, the DAX-30 closed a modest two points higher, at 6,818.

Across the Atlantic, financials led the Dow Jones 176 points higher to a close of 12,383 on hopes that weak housing data would prompt a Fed rate cut this week. The tech-rich Nasdaq climbed 23 points to end the day at 1,353. And the S&P 500 was also 23 points higher, at 2,349.

In Asia, stocks took their lead from Wall Street and made good gains today. The Japanese Nikkei was up 390 points at 13,478. And in Hong Kong, the Hang Seng was 238 points higher, at 24,291.

Gold, silver and platinum reach new historic highs

Crude oil futures were steady at $90.85 this morning. In London, Brent spot was at $91.78.

Spot gold hit a fresh high of $929.40 today before falling back to $924.10. Platinum also reached a new high of $1,735. Silver, meanwhile, reached its highest level since December 1980 - $16.76 - then slipped back to $16.67.

Turning to the currency markets, sterling was at 1.3455 against the euro and was little-changed against the dollar this morning - at 1.9871 - as investors await the outcome of the Fed's latest rate-setting meeting. And the dollar was 0.6769 against the euro and 106.69 against the Japanese yen.

And in Londonthis morning, mortgage bank Alliance & Leicester said that 'core profit' for 2007 (which excludes the £155m of writedowns on its structured investment vehicles) will be at least £598m. Shares were down just 0.9% this morning, with analysts suggesting that credit-related losses had already been priced in.

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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.