Spain In The Vortex Of The EuroZone Debt Hurricane

Like us on Facebook

Somewhat more good news arrived in the form of a successful auction of Spanish government bonds, proving the state still has the ability to generate money, amidst a darkening backdrop of severely high debt and imminent austerity programs.

Still, the overall picture in the land of Picasso and Dali is not good.

The Spanish economy has been in recession for at least the past two years and currently features a staggering 20% unemployment rate and a budget deficit that is an absurdly high 11% of GDP (better than the corresponding Greek figure of 13%, but way above the EU's target of 3%).
Consider that in November 2008, just after the collapse of Lehman Brothers, Spain's jobless rate amounted to just over 13%.

According to the MSCI indices, Spain's stock market has fallen more than 30% year-to-date, making it second only to Greece as the worst performer in the EuroZone.

The government of Prime Minister Jose Luis Rodriguez Zapatero has sought to cut the deficit by, among other things, imposing a 5% reduction in the salary of public sector employees and to cut the severance payment for laid off workers to 33 days per year of work from 45 days. A proposed consolidation of banks may also be in the pipeline.

Cox is skeptical of the success of Spain's proposed austerity measures, primarily due to hostile opposition from the powerful unions and Socialist politicians. Indeed, a nationwide general strike has already been called for September.

Much of the nation's financial quagmire stemmed from the collapse of the real estate/construction boom in the early part of the decade – resulting in dozens of Spanish banks which got stuck with huge unpaid loans. As a result, banks in the country have found it extremely difficult to find friendly lenders in the interbank market (aside from the ECB).

Indeed, Spanish banks borrowed a record 85.6-billion euros from the ECB in May 2010, twice the amount that they borrowed before the collapse of Lehman Brothers,

“There is significant concern about the state of some Spanish banks,” said Raj Badiani, IHS Global Insight economist. “Clearly, [the] Spanish financial system is buckling under the weight of heavy real estate debt. The increased uncertainty about the health of Spain's banking sector has increased pressure on the country's unlisted regional savings banks to come clean about property debt-related losses and to speed up consolidation of the sector.”

Badiani indicated that according to central bank data, “the exposure of the Spanish banking sector to property-related debt stood at 445- billion euro at the end of 2009, or about 43% of nominal GDP.
“This exposure consists of all loans to construction firms and property developers, involved in residential construction and property development in other sectors like energy, airport infrastructure and activity arising from public investment.”

Spain's biggest banks such as Santander and BBVA appear to be sound, Badiani noted, but “there is concern over the health of the country's regional savings banks and small banks, which appear to hold a significant slice of the 445-billion-euro property debt.”

In addition, banks from other European nations are said to have significant exposure to Spain's troubled banks.

According to the Bank for International Settlements, European banks' total exposure to Spain amounts to some 600-billion euros, with German banks holding the largest piece at about 202 billion euros. French banks also have sizable exposures.

Timothy Courtney, chief investment officer at Burns Advisory Group, noted that European banks have larger exposure to Spanish bonds than they do to Greek or Portuguese bonds, so the risks posed to the system are larger in case of a Spanish default and the market’s response would be significant.
“But currently, the market seems to think that Spain will eventually pull out of its current situation of economic contraction and very high unemployment based on relatively low Credit Default Swaps pricing and the market’s acceptance of the recent auction,” he added.

With respect to soaring bond yields in Spain, Badiani does not think they present a near-term risk to the country's public finances, “but represent an increasing threat in the longer term given that the public debt ratio is set to surge from 53.2% of GDP in 2009 to peak at 77.5% of GDP in 2014.”

Debt servicing costs need to be contained to allow the government to achieve its target of reducing the public-sector budget deficit to below 3% by 2013.

Indeed, it is widely believed that the EU in concert with the ECB and IMF will stop at nothing to prevent a financial catastrophe in Spain.

“I believe much of the efforts by the EU, led by Germany and France, were done to provide a funding facility in case pressures intensified in larger economies such as Spain,” said Alan Gayle, senior investment strategist at RidgeWorth Investments. “The current actions and evidence suggest that the EU is committed to Spain’s stability and recovery; and that Spain is committed to budgetary reform. However, if either of these factors comes into question, the news will not likely be well-received by investors.”