Friday, April 27, 2012

Will Spain Kill the Bull Market?

You knew it was only a matter of time before some credit agency downgraded Spain right before the weekend. On Thursday, Standard & Poors cut Spain's sovereign credit rating to BBB+ from A on concern the nation will have to provide further fiscal support to the banking sector as the economy contracts.

The assertion that Spain will need a major banking bailout due to a surge in defaults was derided yesterday as nonsense by Banco Santander Chief Executive Officer Alfredo Saenz:
“Mortgages get paid in good times and in bad,” he said in a news conference at the bank’s headquarters outside Madrid. “Anyone raising this problem as one of the issues for the Spanish financial system is saying something stupid.”

There’s more at stake than the credibility of the CEO of the country’s largest lender. If he’s right, investors betting against his bank and the country will lose. If he’s wrong and delinquencies rise, that will weaken the nation’s banks as Spain’s Prime Minister Mariano Rajoy seeks to restore the recession-hit economy. Concern about Spanish lenders already has helped push the country’s 10-year borrowing costs to about 6 percent, adding to concern that borrowing costs may reach levels that prompted bailouts for Greece, Ireland and Portugal.

Saenz’s comments underscore a growing gap between Spanish banks’ statements about the mortgages they hold and forecasts such as those by the JPMorgan analysts for further losses as unemployment exceeds 24 percent. Santander said the ratio of defaults on its home loans fell in the first quarter, while the Bank of Spain said it’s still below 3 percent nationally.

Bloomberg reports that Spanish Economy Minister Luis de Guindos expects foreign investors and real-estate funds to help offload property assets from banks’ balance sheets and ruled out using public funds to shore up the industry:

“A third-party partner is going to enter into this asset management company if the valuation is the correct one,” said Guindos, 52, in an interview in Madrid late yesterday. The government “will set the general rules to do that but without any kind of subsidy. We are not going to put in any money.”

Less than three months after tightening rules to force lenders to recognize deeper real-estate losses, Spain is seeking new ways to convince the bond market that bank losses won’t overburden public finances. De Guindos was speaking just hours before Standard & Poor’s cut Spain’s credit rating to within three steps of junk and data showed the nation’s unemployment rate surged to 24.4 percent, the highest in 18 years.

I can see bond vigilantes and elite hedge funds salivating at the prospect that Spain will be the next Greece, but let me assure you that no matter how bad things are, Spain isn't Greece and speculators trying to profit off some major Spanish calamity will end up getting badly burned.

And as I wrote in my comment on the stay-liquid-and-wait strategy, I doubt we'll see a repeat of summer 2011. Nevertheless, the macro headlines will paralyze many jittery investors who remember the insane deleveraging that took place in Q3 2011. They will be the ones underperforming once again in 2012.

Having said this, there are serious structural problems that are not being addressed. Spain's economy is extremely weak as unemployment soared to 24.4 percent, the highest in 18 years:

The jobless rate advanced in the first quarter from 22.9 percent in the previous three months, the National Statistics Institute in Madrid said today. Unemployment was higher than the median estimate of 23.8 percent forecast in a Bloomberg survey of three analysts. Spain’s inflation rate rose in April to 2 percent from 1.8 percent, a separate report showed today.

Surging unemployment rates from Spain to Italy and Greece are threatening to derail efforts to quell the region’s debt crisis and keeping bond yields close to record levels relative to benchmark German bunds. Spain is home to more than a third of the euro-area’s jobless and more than half of young people have no work, sapping government tax revenue. Spain will miss its 2012 budget deficit target as its economy contracts, the government said on March 2.

The yield on Spain’s 10-year benchmark bond has risen about one percentage point since early March to 5.99 percent today, approaching the 7 percent level that helped force Greece, Ireland and Portugal into bailouts.

The depression conditions southern European nations face right now is a testament to the monumental failure of savage austerity.

Let me repeat what I and many other economists much smarter than me have been telling policymakers, the developed world suffers from an unemployment crisis and the debt problem will only get worse unless policymakers first address the growth part of the equation.

This why Nobel Prize-winning economist Joseph Stiglitz said Europe is in a “dire” situation as a focus on austerity pushes the continent toward “suicide":

If Greece was the only part of Europe that was having austerity, authorities could ignore it, Stiglitz said, “but if you have U.K., France, you know all the countries having austerity, it’s like a joint austerity and the economic consequences of that are going to be dire.”

While euro-area leaders “realized that austerity itself won’t work and that we need growth,” no actions have followed and “what they agreed to do last December is a recipe to ensure that it dies,” he said, referring to the euro.

“The problem is that with the euro, you’ve separated out the government from the central bank and the printing presses and you’ve created a big problem,” Stiglitz said, adding that “austerity combined with the constraints of the euro are a lethal combination.”

The economist said he sees a core euro area of “one or two countries” made up of Germany and possibly the Netherlands or Finland as the “likely scenario if Europe maintains the austerity approach,” he said. “The austerity approach will lead to high levels of unemployment that will be politically unacceptable and will make deficits get worse.”

Youth unemployment in Spain has been at 50 percent since the crisis in 2008 with “no hope of things getting better anytime soon,” said Stiglitz, who is a professor for economics at Columbia University. “What you are doing is destroying the human capital, you are creating alienated young people.”

To push for growth, European leaders could refocus government spending to “fully utilize” institutions like the European Investment Bank, introduce taxes to improve economic performance and use balanced budget multipliers, he said.

If Keynes were alive today, he'd be horrified at the gross negligence on the part of European policymakers who are sacrificing the next generation in the name of ideology. Sooner or later, Merkel et al. will realize that the only long-term solution to this crisis is to adopt Soros' proposals to create and back a fully functional eurobond market.

Procrastination and more political dithering will bring about more economic hardship and fuel more resentment, empowering extreme left-wing and right-wing parties. It's already happening in many European nations. The rise of extremism is the ultimate threat not only to markets and the global economy, but to world peace and prosperity.

Below, Spanish Economy Minister Luis de Guindos discusses the European sovereign-debt crisis, Spanish banks and the outlook for the economy. He spoke yesterday in Madrid with Bloomberg's John Fraher.

Also, Bloomberg's Mike McKee and Sara Eisen report that the problems of Spain are not extending to Europe as a whole and deepening the debt crisis, but concerns remain. They speak on Bloomberg Television's "Inside Track."

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