Monday, June 11, 2012

Monday, June 11, 2012 - The Non-Bailout Spanish Bank Bailout - by Sinclair Noe

DOW – 142 = 12,411 
SPX – 16 = 1308
NAS – 48 = 2809
10 YR YLD -.04 = 1.60%
OIL – 1.50 = 81.20
GOLD + 1.40 = 1597.10
SILV + .05 = 28.58
PLAT + 13.00 = 1450.00

So, here's the headline from the Murdoch Street Journal: “US Stocks Tumble as Spain Bank Bailout Optimism Fades”. And my question is how many phones did they have to hack before they found someone who was optimistic about the Spanish Bank Bailout?

Over the weekend, Spain requested a bailout of up to 100 billion euros ($125 billion) in loans from the European Union to assist its banks. Statements about the deal left several open questions, including the exact amount of aid the country will need and how the funds will be distributed. What exactly is there to be optimistic about? Oh, the Euro did not explode over the weekend – that's a relief but not a reason to be a big time buyer of equities.

It's not like the Spanish Bank Bailout makes anything better, except for the specific Spanish Banks being Bailed-Out. Europe still has a nasty circle of slow or no growth and increasing debt burdens. Greece's first bailout in 2010 sparked a healthy 1.3 percent rally in the S&P 500 stock index on the following day, but subsequent rescues fostered more muted responses.

The reaction after Spain's bank bailout has been the most downbeat of the lot. The four prior bailouts – for Greece and Ireland in 2010, Portugal in 2011 and Greece again in 2012 -- showed the euro's rallies fade within a month, while stocks were mixed, based on various factors.

In the credit default swaps market, where investors take out insurance against the risk of sovereign default, the pattern has been similar. The cost of buying insurance against Greek, Irish or Portuguese default tended to drop after the first two weeks as investors took the bailout news as a sign of relief, only to rise back to pre-bailout levels or higher within a month. After initially falling, the cost of insuring $10 million of Spanish government debt against default rose to 595 basis points, or $595,000 per year for five years. That is just off a record high.

For the Spanish economy as a whole, there has been no debt relief. This is what happened to Ireland. The banks are in healthier shape today, but the country is still in real trouble. In fact, a report by Spain's central bank showed Spanish banks were the main buyers of Spanish sovereign debt last year, essentially making the government dependent on the banks it is now trying to help. The Spanish government bails out Spanish banks, and Spanish banks bail out the Spanish government. And the longer this insanity persists the more likely people are to realize that the entire solution is a big game played on a closed course.

Bloomberg reports Wall Street bankers and traders, given hope by a market rebound in the first quarter, are now seeing earnings and paychecks threatened by turmoil in Greece. Yep it's all about the bankers and their profits and their bonuses. People in Spain have lost their homes, they have lost their jobs, and so clearly the concern here is the paychecks of Wall Street bankers. The government and the banks have forgotten why we have an economy in the first place; we do not have an economy to serve the banks and the government, which are morphing into one and the same. The reason for a bailout is not to make the banks whole. We've seen this game before. It is losing its effectiveness because we can all see through the scam.

Wait just one minute; just a week ago, Spain was saying they didn't want a bailout, they didn't need a bailout. What's going on here? Well, technically it is not a bailout, it is a line of credit to Spanish Banks. What's in a name? A rose by any other name would smell as sweet.

So, maybe the better question is whether the bailout that isn't a bailout will work. And the answer is probably not. Spain's access to capital markets and its cost of debt is not being addressed. The last auction of Spanish government bonds saw yield around 6.50% with the bulk of bonds being purchased by local banks. Spain and its banks also face pressure on their own ratings, which are now perilously close to becoming non-investment grade. The bailout may actually adversely affect the ability of Spain and its banks to funds. Commercial lenders are now subordinated to official lenders. Based on the precedent of Greece, this increases the risk significantly, discouraging investment.

The amount – 100 billion euro or more depending on the independent assessment of the needs of Spanish banks- may not be enough. The capital requirements of Spanish banks may turn out to much higher – as much as 200-300 billion euro. And since the money is going to rebuild the banks instead of rebuilding the economy, you will have banks that won't make loans to people who don't have jobs, and the nasty downward circle continues to swirl. The bailout will be provided with no conditions, which creates its own problems. The lack of conditions may lead to Greece, Ireland and Portugal seeking relaxation of the terms of their assistance packages.

The relief in Rome was short-lived. Italian bonds rallied early but within hours, Italian borrowing costs were creeping back up again, reflecting persistent market fears that the Continent’s third-largest economy could be the next to falter. Contagion into Italy and other countries is a reality. There seems to be little Italy can do to protect itself. Technocratic Prime Minister Mario Monti, appointed last November to succeed Silvio Berlusconi, has tried to shore up finances, overhaul the pension system, and implement regulatory reforms. The country is on track to bring its budget deficit within 3 percent of GDP this year. Italian banks are relatively healthy, and unemployment is less than half the 24 percent in Spain. Spain’s fundamentals are much worse than Italy’s.

Italy’s situation is hardly rosy. Its debt burden—120 percent of GDP—is the highest of any European country except Greece. Its economy slid into recession during the fourth quarter of 2011 and is expected to contract 1.7 percent this year. Monti’s reform agenda is stalling, unemployment at 10.2 percent is the highest in a decade, and consumer confidence is the lowest in 15 years. Italy is positioned to be the next lightning rod in the euro area. For now, yields on Italian debt are at 5.84 percent, less than they were when Monti took over last year.

Apparently the idea of the non-bailout, no pre-conditions Spanish Bank Bailout was that it would appear as if Spain itself is not paying for the bailout. In other words, it was a gamble by the Spanish government to avoid a general government bailout. The gamble failed; the Spanish government will now own this bailout and they will soon be stuck with the same kind of conditions imposed on the Greeks, and this will continue until it ends badly.

So much for a firewall.

The Federal Reserve has release a new study that shows the average American family lost 38.8 percent of its wealth from 2007 to 2010, with the biggest losses concentrated among households with the most assets tied to their homes. Fed economists conduct the surveys every three years to produce a snapshot of household balance sheets, pensions, income, and demographics that’s more detailed than broader reports about the economy. The surveys allow comparisons over time, with a consistent methodology since 1989.

Median net worth declined to $77,300 in 2010, an 18-year low, from $126,400 in 2007, the central bank said in its Survey of Consumer Finances. Mean net worth fell 14.7 percent to a nine-year low of $498,800 from $584,600. Just a reminder, the “mean” is the average while the “median” is more like the midway point.

The impact has been a massive destruction of wealth all across the board and especially for the broader middle class, or what once was the middle class. The decreases in median net worth appear to have been driven most strongly by a broad collapse in house prices.

The housing slump and financial crisis also boosted the dependence on wages as a percentile of net worth for the wealthiest 10 percent. The top 10 percent by wealth got 55.8 percent of their pre-tax family income from wages in 2010, up from 46.2 percent in 2007, the survey found. The portion earned from capital gains plunged to 2.3 percent from 14.4 percent. Once upon a time it was a widely held belief that the wealthiest would be able to pull the economy out of a downturn, but the uber-wealthy are a small proportion of the overall population and they can only account for a tiny fraction of the consumer spending you might expect from hundreds of millions of consumers who have been forced to tighten their belts.

Debt as a share of family assets rose to 16.4 percent from 14.8 percent as asset values declined. For those households with debt in 2010, the median value of debt was unchanged from 2007, while the share of families having debt fell to about 75 percent from 77 percent. Debt payments more than 60 days overdue were reported by 10.8 percent of families in 2010, up from 7.1 percent in the prior survey. Measures of debt payments relative to income might have been expected to increase. In fact, total payments relative to total income increased only slightly, and the median of payments relative to income among families with debt fell after having risen between 2004 and 2007. The share of families with high payments relative to their incomes also fell after rising substantially between 2001 and 2007. If there is any one thing that makes sense during these difficult economic times, it is to cut or eliminate debt.

Fed policy makers meet next week to consider whether the central bank needs to add to its record stimulus after employment grew at the slowest pace in a year in May.

The Fed has already cut its key interest rate almost to zero and injected hundreds of billions to bailout banks and purchased a few trillion in debt to lower long-term borrowing costs. Even so, the jobless rate has stayed above 8 percent since February 2009, compared with the central bank’s long-range goal of 4.9 percent to 6 percent. Why? Because the actions taken by the Fed were more consistent with saving the banking and financial sector than with fulfilling its mandate of maximum employment. I don't know if it is impossible for the Fed to bring down unemployment with monetary policy alone, only that their policy has not done the job even though it has benefited the banksters, you know, just like what's happening right now over in Europe. 

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