Wednesday, May 30, 2012

The Only Thing Worse Than a Federal Government... not having one when you need one.  The above represents the latest available data for unemployment rates in the PIIGS countries (data through March, except only through Feb for Greece).  Spain and Greece in particular continue to spin wildly out of control.

As far as I can tell, there is still no coherent approach to managing the situation, which will therefore continue to get worse.  The latest twist is that Spain is signaling that it cannot afford to rescue Bankia (a hastily assembled consortium of regional banks that is now insolvent due to bad real estate loans made during Spain's property boom).
Bankia is the poster child for these bad banks. It's the unholy progeny of seven troubled cajas thrown together. Not so shockingly, it turns out that it's just as easy to fall together as it is to fall separately. After getting a €4.5 billion capital injection from the government, Bankia recently revised its 2011 earnings down by a modest factor of 100 -- although we should cheer up, because it might be twice as bad. Now, Bankia needs at least another €19 billion to stay afloat.

That's roughly €19 billion more than the Spanish government can come up with right now. Over the weekend, the government admitted that its borrowing costs are too high for it to raise that much money in the bond market. But the government did suggest an eye-popping alternative. They proposed recapitalizing Bankia with €19 billion worth of Spanish bonds, that Bankia could then use as collateral at the ECB for new money. It that sounds suspiciously like asking the ECB to print money to bail out its banks, that's because it is.

This is a fairly frank admission that Spain is insolvent. The ECB has financed nations through the backdoor before -- Greece and Ireland come to mind -- but that's certainly not a club Spain wants to belong to. It's a reminder of how dire things really are in Spain.

There are two broad stories about the ways they are doomed -- though these are hardly the only ways. First, Spain is supposed to trim its budget deficit some 3.6 percent of GDP this year alone. That's an impossible task that will only push Spain further into depression, as their economy falls more than they save. And second, the ongoing collapse of its banking system is starving the private economy of credit. Small and medium-sized businesses can't get loans. It's the same dynamic Ben Bernanke famously observed in the U.S. during the Great Depression: As cajas fold into each other and shrink their balance sheets, they lose the local knowledge they need to make loans to smaller, riskier customers. A credit crunch follows, even if the economy recovers -- which it's not. That's how you get retail sales falling 9.8 percent from the previous year. Neither businesses nor customers have enough money to keep going on. It's a vicious circle down.

Only the government can stop a complete collapse. Except the euro stops the Spanish government from doing so. That leaves Europe to bail Spain out. The ECB isn't likely to go for not-so-stealth money-printing, so that means Germany and France will actually have to put money in their mostly imaginary bailout fund.  It will be enormously expensive.

But the only thing more expensive than bailing out Spain is not bailing out Spain. Of course, the people don't necessarily think about these counterfactual costs, which is why there's a real danger of a TARP-like political backlash once the full costs of the euro become clear.
So now rescuing Bankia becomes a matter for long, painful, and no doubt leaky negotiations between European leaders.  A worse way to handle financial institution rescue cannot be imagined (since it gives customers, lenders, etc the maximum window of uncertainty in which to withdraw funds from the affected institution and make matters worse).

It seems clear that the EU cannot function without a strong central government.  It now appears that Spain is reaching the point where it will need to be bailed out at the same time that Greece is in electoral limbo due to voter backlash at their bailout conditions.  It seems that things are coming to a head.  On present form, it appears likely that one or more nations will be leaving the Eurozone this year.  It's either that or the EU will need to develop stronger institutions in a hurry.

1 comment:

kjmclark said...

Geez, I would have thought we'd debunked Bernanke's "observation" - these days most of the small loans are done on credit cards, and the decisions on extending credit are done in software. No chance of losing that expertise. But we're getting about the same result - very little lending and sticky recessions.

Bernanke's real insight this time is that throwing all caution to the winds to rescue the banks results in a dramatic political backlash that shuts off the possibility of fiscal solutions. So much for the 'rescue the banking knowledge' idea.

Europe seems to be dragging oil prices down with it.