Saturday, June 16, 2012

The cynic’s take on the Spanish bailout

Perhaps I’ve just watched too many episodes of Hustle, but the whole series of events that led to the bailout of Spain seems awfully contrived to me.

Remember earlier this year, with the whole debate about what the deficit for 2012 would be? Anyone still care? No? How convenient.

The funny thing was that at the time people were really scratching their heads at Rajoy’s promised cuts, because it wasn’t clear that the central government even had the power to make the cuts, since most of the cut-able expenses have been devolved to the regions.

A month after conceding the cuts, which were pretty much impossible to accomplish, all of a sudden a 40 billion euro hole is discovered in BFA-Bankia, which had been run by Rodrigo Rato, a party loyalist. The strange thing about the mess around Bankia was the curious lack of enthusiasm in defending the viability of Bankia, since in theory all the bad assets had been ring-fenced to its parent company BFA. The head of the Spanish Central Bank (who was responsible for supervising BFA) was hurriedly gotten rid of, and apparently the employees of the Central Bank were pretty pissed off at being made fall guys.

So suppose for the sake of argument, that the hole at BFA/Bankia is really more like the 4 billion originally floated around. With an extra 36 billion in capital, BFA/Bankia could go on a major shopping spree of Spanish Government bonds. Since the bonds can be lent to the ECB for 95% face value, this means that with the 36 billion in capital, Bankia could buy up to 720 billion euros of Spanish government debt! Since Bankia would be pretty much 100% owned by the government at that point, any interest paid on this debt would still be owned the government itself.

The big advantage of this approach vs the ECB buying a bunch of Spanish debt is that there isn’t the same problem of subordination, since the ECB never has to buy a penny of Spanish debt.

The real scam here is that by the “restriction” that the 100 billion be only used to bail out the banks is actually a feature, not a bug. It means that the Spanish government can take this 100 billion and leverage it 20:1 by putting it into a bank that it effectively owns.

Once everything is in place, it doesn’t really matter what interest rate the Spanish government sells bonds for, since they can buy they up more or less directly by their own puppet bank (up to whatever limit that they can leverage the 100 billion to). In fact, this can also be used to retire debt below face value, since if the government (err I mean bank) buys its bond at discount, as long as it hold onto the bond until maturity, the discount is effectively free money for the government.

The only real problem with this scam is that (1) it is complicated, and a lot of things could go wrong, and (2) it will take a fair amount of time to make this work, time that the government may not have.

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