A rescue to save the euro

 The Eurogroup works against time to recapitalize Spanish banks and stabilize sovereign debt to tackle doubts about the single currency

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 Yesterday we were on the edge of the abyss. Today we have taken a step forward! “… The rhetorical delirium attributed to former Chilean dictator Augusto Pinochet illustrates well the risk of derailment facing the euro zone these days with its plan to help Spain to clean up its banking system. 

It was thus, as a step forward before the precipice, as the financial markets seemed to interpret the announcement that the European rescue fund will inject capital into Spanish banks through a loan to the State: the beneficiaries will be the entities but the person responsible for returning it (and of assuming possible losses) will be the State, a perspective that triggered the risk premium of the Spanish and Italian bonds at unknown levels.

Fear of failure

Image result for fear of failureThe fear that the operation will fail and make a total rescue for Spain inevitable (not an intervention of its financial sector but of the whole economy) has forced the euro zone to revise its plans. European governments have been willing to explore in depth the entire catalog of options available to chisel a rescue really tailored to the Spanish case. The pressure of Mario Monti, Italian Prime Minister, has taken a fundamental turn to the debate. The G-20 summit in Los Cabos (Mexico), held in a climate of emergency on the impact of the European crisis on the world economy, was the forum chosen by the skilled Italian technocrat to raise the possibility that the rescue fund European Union intervenes in the debt markets and relax their pressure.

I could not have chosen a more receptive audience. The mere mention of this possibility – provided in the regulations of the rescue fund since last year – has served to relieve pressure on peripheral sovereign debt. The challenge now is to finish off the play, so that Monti’s pass becomes a bit in favor of the euro that dissipates doubts about his future.

All eyes are on the summit that the EU and the euro zone, in a restricted format, will hold next week in Brussels. Expectations are high: Germany and France must agree to give a future perspective to the euro but also to provide solutions to their immediate problems.

Under pressure from the International Monetary Fund, the euro zone has reopened the debate on whether the EU should lend money to the banks without going through the states and without contaminating their problems. Berlin vetoed the proposal last year, but Mariano Rajoy does not rule out that Angela Merkel give in to the pressure and agree to put it in motion, in time for at least part of the rescue operation of Spanish banks.

In parallel, the Eurogroup is studying the launch of an operation to buy Spanish and Italian debt in the secondary markets through the European rescue fund, the place of the reticent European Central Bank. It remains to be seen what price the European partners put, what political conditions they impose in exchange for buying a truce from the pressure on the risk premium. The euro zone wants to close the operation as soon as possible. Not at the end of July as expected by the Government but at the meeting of the Eurogroup next day 9. It will be that day when we know the final amount of credit line that will be offered to Spanish banks and savings banks that need public capital, always in exchange of the implementation of restructuring plans (sale of assets, closing of offices …) that are announced as very severe.

Image result for olli rehn“It is essential that banks in Spain can fulfill their primary role, which is to provide fuel to the economic engine, give credit to households and businesses instead of fueling speculative activities,” said the European Commissioner for Economic Affairs, Olli Rehn. In parallel to the restructuring plans, Brussels and Frankfurt could also request reforms in the Bank of Spain to avoid repeating past supervisory failures.

The comment is also made in German government circles, although more refining. The problem of Spain, they admit, has its origin in the private one, in a real estate bubble that took too long to detect and control. The case is compared to what happened in the United States and Ireland, but they qualify: in these countries the phenomenon was very much financially sound, but in Spain cement was really used … ‘Never more’, they say in Berlin. In its official account of the crisis, however, the role of the German banks does not enter the ‘Spanish party’, as the international press calls the boom of the past decade.

The arrival of the Socialist François Hollande in the Elysee has left in suspense several decisions that the EU had left precooked during the French elections: the relay of Jean Claude Juncker as president of the Eurogroup, the replacement of José Manuel González-Páramo in the executive council of the Bank European Central Bank (ECB) and the appointment of a director for the European permanent rescue fund. Hollande is craftily playing his cards and has paralyzed all three decisions. According to several diplomatic sources, not so much because of divergences on the candidates as for strategic reasons. The French leader is reluctant to give Angela Merkel the quota of additional power that would involve placing his Economy Minister, Wolfgang Schäuble, as president of the Eurogroup. Trying to deactivate Hollande’s move, the German chancellor has warned that she will not make a casus belli of that appointment … But until they unblock this point, the appointment of Yves Mersch, governor of the Bank of Luxembourg, as a member of the ECB directory. Neither did Belén Romana as director of the rescue fund. The only irreversible in these three movements is the departure of Spain from the kitchen of the decisions of the ECB.

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The rescue of the Spanish banking sector could accelerate the plans of the European Central Bank (ECB) to dispense with private rating agencies to value the collateral it requires in its liquidity operations. The issuer is not prepared to carry out the delicate mission, both technical and political, of making its own valuations on sovereign issuers. But, according to Reuters, has reached an agreement to make life easier for Spanish banks relaxing their demands on the use as collateral of public debt and mortgage. Throughout the crisis, the ECB has on several occasions lowered its standards on the guarantees it requires from banks. If a decision is not made in this sense, if the Canadian agency DBRS also downgrades Spain’s solvency rating (as Standard & Poor’s, Moody’s and Fitch have already done), Spanish bonds are destined to assume a 5% penalty to be accepted as collateral. This step represents an important turn to reduce the influence and dependence of the agencies, while the ECB is spreading new heights of power in the eurozone. The Bundesbank has already distanced itself: “We will not accept what we do not have to accept,” said its spokesman, Michael Best.