As political instability reigns in Greece, Spain's risk premium has reached 477 points, a high not seen since Spain dropped the peseta and went on the euro. The Spanish stock market settled at 2003 lows and the Treasury paid 2.98% on an issue of 12-month notes, a 14% year-to-year increase. This is how the market is responding to Prime Minister Rajoy's second set of financial reforms in five months. Last Friday this publication noted that Rajoy's reforms would fall flat, because they do not achieve the full sector restructuring that is necessary.
Basically, it is not immediately clear how to solve the main problem: splitting off toxic real estate assets and cleaning up balance sheets. The German representative for the European Central Bank (ECB) gave this warning the day before the Spanish cabinet made its final decision about reforms. The strength of these reforms depends on several banks that are in no condition to carry them out. The Cabinet chose this route under heavy pressure from the Treasury, which pushed for providing the banks all the backing that they could need despite the strong possibility that these funds will be hard to come by through debt issues or any other means.
The situation recalls what happened to Ireland in 2010. In order to restructure its financial sector and ease market anxiety, Ireland had to ask the EU and the IMF for 80 billion euros. Spain, before approving the latest round of financial reforms last Friday, asked the EU for aid. The EU did not deny funding, but offered it in exchange for a formal intervention. The crisis has been going so fast and furious that now, just two days after the Cabinet tried one more time to right the financial system, we are running the wrong way down a dead-end street. The government can't answer the questions about our future when most people in the marketplace are betting on a bailout.
Further, the government has not been precise in its assessment of the situation and in its communications. Minister Luis de Guindos decided to dismiss Bankia CEO Rodrigo Rato five days before approving the newest financial reforms as if an event as significant as his leaving Bankia would not have a major influence. Yesterday, De Guindos had no qualms about blaming what is happening in Spain on instability in Greece and, at the same time, asked for Europe's sympathy. Spain's rising risk premium "has more to do with Greece than with the soundness of our financial reforms" he stressed, speaking from Moncloa. We've been living through these back-and-forth circumstances for too long, and each time the rocking gets more intense such that we can't see the disastrous implications instability is having on the Spanish economy and financial sector.
The Spanish treasury, which had the good sense to launch a series of debt issues earlier this year, could afford to issue all remaining debt at current interest levels if it has to, but it can't if rates go up much higher. Further, companies badly need credit that they can't get at this time. And credit will never become available under current circumstances. Aid from the ECB is the only solution for easing doubts and keeping an intervention at bay. Draghi could authorize purchases of new Spanish debt on the secondary market and thereby inject some liquidity into the country?s financial sector. If that does not occur, then we are increasingly close to a bailout. Luis de Guindos ought to know that time is expiring. The markets are telling him that his financial reforms are not easing widespread doubts and that he can't hide behind Greece any longer.
