SPANISH PIPE DREAMS, by François Leclerc

Guest post. Translated from the French by Tim Gupwell.

A Euro trading this morning at 1.2389 dollars, and sharply rising bond rates, reveal that capital continues to flow out of the Euro zone and that investors are selling Spanish and Italian bonds (both tarred with the same brush) whenever they can. They are also seeking refuge in the purchase of American, British or German debt whose rates are historically low, a phenomenon just as worrying as the rising costs of the others. German two-year bonds issued with a zero coupon, something never seen before, while the Spanish have to pay 6.7% and the Italians more than 6%. The most worrying aspect being that the fate of Italy is linked to that of Spain.

There has been no lack of hasty secret meetings, including with the Americans. Yesterday, the Spanish minister of the economy Luis De Guindos met up in Berlin with the German finance minister Wolfgang Schäuble, without any of the content of their discussions filtering out. Steffen Seibert, spokesperson for the German government declared to journalists that “the German government has faith in structural reforms pursued by the Spanish government”. In the afternoon, a telephone conference was held, involving Angela Merkel, Barack Obama, Mario Monti, and François Hollande (as at every occasion when the discussion is serious, nothing came out of it). The vice-president of the Spanish government, Soraya Saénz of Santamaría, has been dispatched to the United States, where she is due to meet Christine Lagarde and Timothy Geithner.

In the surrounding deafening silence, all that can be heard are denials from the German and Spanish. The liberal German minister of the economy, Phillipe Rösler, asserted that “the problems currently affecting the Euro Zone can be sorted out by a swift ratification of the budget discipline pact, which will send a strong signal to the markets that Europeans are prepared to defend their currency”. With regard to the failed attempt to recapitalize Bankia, Luis de Guindos, his Spanish counterpart, declared, that (against all proof to the contrary) “the Spanish government has presented no plan to the Central European Bank and that the European Central Bank has not rejected anything”.

Passing to more serious matters, once again the European authorities have been caught off-guard. They were just getting ready to decide on the creation of a “European Banking Union” in next month’s summit which was going to solve all the problems and kick the Spanish crisis further down the road. That was before the intervention of Mariano Rajoy, who must be held up to public ridicule.

The new plan in the pipeline has been prudently put forward as one that needs to be implemented in stages and is based on an obvious and only belatedly recognized fact: private debts need to be disconnected from public debts so that they can be treated separately to avoid cross contamination. To describe it pictorially, it’s like cutting a hot potato in two so that it cools down more quickly.
Attending to the most urgent things first, a European deposit guarantee fund ought to help to reduce the systemic risk, so that depositors are not encouraged to flee to safer havens, plunging the banks into disarray. This possibility haunts the authorities as they sense the possibility of impending catastrophe in Spain.

The “European Banking Union” is based on pooling the banking losses and financing them by a banking tax. The idea is to raise an annual subscription representing 1% of deposits, and to oblige the shareholders and creditors to pay first and foremost so as not require contributions from the member states. If necessary, this structure could have additional access to the European Stability Mechanism (ESM), or even to the ECB (passing by the former), but these measures – which utilize public funds – need to be fine tuned and adopted. In a climate of confidence, such a structure could freeze the payment of dividends and change the management of a bank in difficulty, in order to take over the reins and to mount the salvage operation, while the ECB would supply liquidity to keep it afloat.

For this structure which is still in the planning stage, the devil is in the detail. One fundamental question has not yet been resolved: given the serious implications of such measures, what kind of preventative criteria will be adopted to avoid them coming into play too late? Will their announcement not precipitate the very kind of collapse they are designed to avoid? Perhaps the European Commission’s presentation of the project, scheduled for the 6th June, will tackle these questions.

With the problem of the banks resolved, there remains that of the member states. On this side, the projects are not so far advanced, after having kicked off with an ode to growth which found little support. The objectives have been identified, but the means to achieve them have yet to be found. They are threefold: allow states in difficulty to finance themselves on the market at better rates, find a means of improving their fiscal receipts, and find a way of spreading the deficit reduction over a longer period so that it becomes achievable.

The implementation of this road-map supposes the possibility of an agreement on Eurobonds, about which Pierre Moscovi (the new French finance minister) and Jean-Claude Juncker attempted yesterday to outline between them the contours, attributing to them only the objective of a partial financing of the debt, say up to only 60%, so as not to frighten everybody off.

The further pursuit of the debate about Project bonds and their financing should lead to definition of a second strand, though the means of ensuring they have an immediate impact (as François Hollande demands) remains to be found. Finally, based on the model which has just been meanly accorded to Spain by the Commission (though still subject to confirmation), where it had previously been refused to Belgium and Holland, a smoothing out of the deficit reduction payments over a longer period will put the finishing touches to the edifice. This will merely be a way of bringing forward what would have had to be accepted anyway.

Such a context, once adopted, would enable the debt reduction strategy to be maintained, after having generously modified it. The banks should become more autonomous, and the noose around the neck of the states would be loosened somewhat. This sparkling plan ‘A’ is far from being accepted, due to the unshakeable opposition of the Germans; its initiators counting on the new developments of the European crisis to progressively overcome them.

However, this plan does not set out with what pieces of string the Spanish banks are going to be patched together, and how the states and regions are going to be able to continue to finance themselves. Greece remains an unknown quantity, on which a silence is maintained, eyes fixed on the electoral opinion polls which establish alternately the winners as New Democracy and Syriza. In both cases, a renegotiation of the “memorandum” will be unavoidable, but the uncertainties remain tremendous in the latter case and could foil this plan.