Investors remain undecided about the success of the Spanish bank bailout plan, in part because the details of the deal have not yet been finalised.While economists generally agree that this is not a “solution” to the crisis, they continue to debate whether or not this is even a step in the right direction.
Three issues in particular top their worry list:
Stipulations for the government
In its request for aid, Spain specified that it only sought help for the financial sector, which has been crippled under the dual burdens of a housing bubble and a sovereign debt crisis, and not for the government. But the Eurogroup’s response to the Spanish request shows that—whatever Spain’s desires—their loan might come with a bit of that dreaded government conditionality.
In its statement accepting the Spanish government’s appeal for aid, the Eurogroup said that “the policy conditionality of the financial assistance should be focused on specific reforms targeting the financial sector, including restructuring plans in line with EU state-aid rules and horizontal structural reforms of the domestic financial sector” [emphasis added].
However, reports today that officials from the so-called “troika” of EU countries, the European Central Bank, and the IMF would be responsible for administering the loan troubled investors concerned that the bank funds could come along with strict conditions on the Spanish government. In the cases of Greece, Ireland, and Portugal, such restrictions have often proved damaging to economic growth, pushing countries deeper into recession. Analysts are worried that similar policies would push one of Europe’s biggest economies even deeper into recession, and continue the hard-line austerity ideology that seems to be failing elsewhere.
Will it divorce financial risk from country risk?
The restrictions any bailout imposes on the Spanish government will be crucial to the way markets view the connection between the Spanish government and the Spanish financial sector moving forward. It appears to be in the best interests of leaders to insulate the Spanish government from the effects of domestic financial sector distress, which will likely stop them from placing bank performance-based restrictions on the loan.
But if we are to assume that any EU loan has little bearing on the Spanish government (as we noted before, this is not a certainty), then there are two possible ways this could play out:
BEST CASE: Game-changer for Europe: Any bailout that transfers the weight of Spain’s banking sector to the shoulders of the European Union marks a monumental shift in European policy, as this is a strong move towards banking union and fiscal integration. Further, this could mean a huge reprieve for Spanish borrowing and Spanish equities, as the
WORST CASE: Even more angst about Spain: The bailout plan fails to truly transfer the weight of the banking sector from Spain to Europe. Regulations imposed by EU leaders on banks cut off their willingness to purchase Spanish government bonds, and Spain continues to have difficulty finding funding.
Debt subordination clauses
According to the current plan, both the EFSF and ESM bailout funds will lend to the Spanish Fund for Orderly Bank Restructuring (FROB), which will in turn use the aid to recapitalize banks. Because the Spanish bailout will not change the way in which Spain accesses financing from the markets (in Irish, Portuguese, and Greek bailouts these governments had stopped seeking market financing), this presents new legal challenges for investors.
Under the current terms of the not-yet-approved permanent ESM bailout fund, European lenders will automatically subordinate any other claims to their cash when they lend. In the past, the EFSF had no clause stipulating this subordination, although in Greece EU government lenders—like the IMF—did not take losses on their holdings will private sector lenders did.
The fact that the new bailout fund makes this subordination explicit could be problematic. Some Spanish bonds (typically off-shore) include specific clauses against subordination. Violating them could potentially cause credit default swap contracts to trigger. That said, investors who spoke with Business Insider have mostly characterised this debacle as a “sideshow.”
The more realistic concern has to do with investor sentiment. Knowing that they would be forced to take losses in a debt restructuring, investors might be less willing to take a gamble on Spanish government debt once it starts receiving money from international lenders. Even though the funds are destined for banks and not the government itself, the Spanish government must still carry this risk on its balance sheet. Thus, it is conceivable that any bailout will simply push Spanish borrowing costs higher, and eventually bar them from market funding.
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