When words matter more than substance

MADRID | All of the sudden, the feeling things might be spinning out of control has cast a gloomy mood in Spain. For a country lavishly living on others savings, finding itself short of cash has come as a shock-horror revelation. It now faces the unsparing rigour of lying in the hands of fickle and merciless markets. The deep-rooted assumption that confidence gap would be bridged as soon as the new government took office lasted only a couple of months. Ever since, we stand at the forefront in euro’s raging battlefield, Italy having managed to take shelter at our rear.

Only a few weeks ago the mere possibility of asking for help was defiantly shrugged off. Reaction then was confined to put the blame on Greece’s slide towards euro exit or sulking at German stubborn stance on austerity. But attempts to transfer the onus on others hardly served to alleviate the on-going plight. Help has now become an unavoidable option, even if frantic efforts are undertaken to avoid a full scale rescue. Spain, EU institutions and main partners are working against the clock to camouflage intervention by targeting support to ailing banks.

The obvious aim stands to avoid crossing the red line leading to an overt bail out no one seems inclined to trigger. Yet, for all the endeavours in providing a palatable façade to this downgraded financial salvaging, Spanish inability to tap enough resources to foot the bill emerges as the only unambiguous and hardly reassuring conclusion to be drawn. You may label that shortcoming as you wish, but pretending it bears no similarity with a rescue plan will not fool the markets. Spain is confronted with a dismal outlook no matter the outcome this plan might lead to.

Devising such a scheme does not attempt to circumvent budgetary discipline, or to indulge in a deceitful artifice for evading market pressure. Rather, it aims to ring-fence the acutely required financial system revamp, thus preventing contagion to public accounts and extensive spill-over damages to the economy as a whole. It also signals the firm conviction that rescue plans implemented so far would prove utterly unsuitable to address the Spanish shortcomings. A view supported by the appalling record shown by past interventions. This backstop mechanism has no doubt saved sovereign debts from sheer bankruptcy. But they barred access to finance for the private sector, thus delivering a more severe blow to output than any austerity package.

By focusing almost exclusively on budgetary concerns, rescue plans have openly neglected the pressing demand to deliver growth, the only safe recipe together with structural reforms to bridge deficit on a sustainable basis.

The case for avoiding a full-fledged rescue does not entirely rest on an open recognition that Spain is entitled to receive a different treatment for curing its ailments. It mainly stems from sheer reluctance from our partners to finance the massive support such a huge economy needs. A concern much exacerbated by the prospect the crisis might spread to Italy, plunging euro zone into a nightmare scenario. Thus, claims by the Spanish government that euro survival is fought on our soil are fully valid as our neighbour’s fate is close connected to what might happen to us. So long we don’t drift away from such an anchor, those holding the EU purse will be prompt to engage in earnest efforts to meet our demands, so long costs are kept to a reasonable level.

All sides sharing a keen interest to downsize rescue to a salvaging scheme for the banking industry, broad agreement on substance can be safely considered. But wrapping up a final deal still needs to overcome a number of hurdles. Flat refusal from Spain to accept any conditioning usually attached to standard rescues, could be easily accommodated by imposi

ng strict requirements on beneficiaries and even on the financial reform.

In contrast, firm rejection to receive money through the Treasury instead of channelling funds directly to the banks raises a number of sensitive issues. The legal ban on such a direct support stands as an undisputable barrier. But the blocking issue is how to ensure a solid guarantee covers the amounts to be lent. EU partners can hardly commit their taxpayers’ money on the risky bet restructured banks will turn healthy and repay their debts. They will certainly require Spain to commit itself in footing any potential loss. The idea being floated to use the FROB as a bridging intermediary could serve both purposes, acting as a mere depositary of the funds and providing firm assurances to cover any repayment failure.

This practical solution fails to fully meet government’s hankering for a formula avoiding at all costs the political humiliation of asking for help. That’s why it insists so much in requests being filed directly to the EU Fund by beneficiaries. That’s why it dismisses any proposal that might link this package to a country rescue. These matters of principle are proving particularly irksome to deal with, as partners fail to grasp whether they obey to an eroding tactic or reflect a real bottom line. Discussions are also hampered by the delay in delivering precise clues on the financial situation and needs. Furthermore, once the auditing is completed, we are bound to advance solid reasons to justify the size of the shield against future developments.

Taking Bankia as a benchmark will inevitable raise questions on the rationale of providing ailing banks with a comfortable and far-reaching cushion for potential bad loans and losses. Mario Draghi’s blunt comments on the way this case was managed, points not only to blunders incurred in tackling the crisis. It also mirrors concern at the solution presented. We can hardly expect others to rubber stamp attempts to unduly bolster the competitive edge in ailing banks to the detriment of prudently run entities. Neither can you hope to artificially swell provisions beyond reasonable levels. Nor could help be envisaged without radically downsizing both business and balance sheets. The brilliant outlook in future depicted by its incoming chairman has backfired, extending mistrust on a solution perceived as close to a blank cheque for securing a larger than warranted package on taxpayers’ money. That’s just the kind of message Brussels undoubtedly dislikes.

Stiff conditions are most likely to be imposed on supported banks. Otherwise distortions would stem from extensive use of this exceptional window for revamping balance sheets beyond real needs. Worse than that, any trace of moral hazard would be wiped out should entities be inclined to count on such a safety net regardless of their conduct. Setting a loose precedent would wreak havoc to sound prudential policy. That’s why Brussels might press to introduce a number of resolution principles transferring part of the onus to bond holders and unsecured creditors. Reaching agreement on the concrete lines and figures of the rescue package might prove a real challenge at a later stage of the discussion.

Even allowing for a shift in the German position, it will most probably continue  pressing for commitment on policy issues, in particular financial reform. Spain might be forced to face a difficult choice. Should it cave in to pressure, it could no longer pretend rescue being confined to solve individual banks shortages. But flatly refusing to compromise on this would lead to a doomsday scenario. The relentless tug-of-war on issues of principle has the potential of sparking stormy crisis up to the very end. But now that process is on the move, any hint it might collapse would immediately trigger a devastating effect on Spain and the euro. The stakes are so high as to force both sides to come to terms.

zp8497586rq

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.