The future of the Bankia bailout

The ECB loudly proclaimed (and quickly retracted) that Rajoy’s bank bailout scheme wouldn’t fly because it would “violate the spirit” of central bank financing government spending.

That’s a real step forward, since obviously if it only violates the spirit of the law, it doesn’t violate the letter of the law. Which means that is exactly what’s going to happen. (Ireland basically did exactly the same thing when it rescued its banks, adding even the additional contortion that it somehow managed to borrow the money without increasing their deficit.)

Given that all the other alternatives require treaty changes or treaty breaking, what else is really going to happen?

Never underestimate the ability of the ECB for bureaucratic stupidity

Looks like Rajoy chickened out in the end, just like he did before with the fight of the deficit numbers for 2012 (anyone still care when it is supposed to be 5.3 or 5.8%? hahaha).

The ECB said yesterday that the Spain’s plan to directly inject debt into BFA-Bankia was unacceptable and amounted to monetization. Instead, the ECB demanded that the Spanish government raise the money required on the bond market.

The stupidity of the whole exercise is that this is purely a question of appearances. Suppose the Spanish government goes and sells 19 billion in debt on the market, then injects the cash raised by this into BFA.  So what’s stopping BFA from buying 19 billion euros of Spanish government debt with this cash? Since the government effectively owns 100% of BFA, it doesn’t matter how many contortions it goes through to funnel cash into BFA, because at the end of the day it is just borrowing money from itself.

The only other alternative would be for BFA to raise the money from “the markets”, but that obviously won’t work since BFA is worth a (very large) negative amount of money. The classic way of getting around this would be for the government to sell BFA to a private entity for 1 euro, along with a guarantee covering the negative amount (this is what they did with CAM earlier this year). Good luck finding any private entity left in Spain that could make that kind of investment.

Spain threatens the nuclear option to recapitalize BFA-Bankia

I don’t think people realize the huge significance of the proposed plan to recapitalize BFA-Bankia. The Spanish government will print a 19 (or is it 40 now?) billion euro bond and place it directly on the balance sheet of BFA, in exchange for essentially 100% equity of BFA.

The bond is never sold on the public market, so the interest rate of the bond is irrelevant. Since the government owns 100% of BFA, any interest the government pays on the bond goes right back into their own pocket.

From the ECB’s perspective the bond is as good as any other Spanish government bond, so it can be lent to the ECB in exchange for real Euros, which the bank can use to buy a number of things, including Spanish government bonds. The key part is that the bank only needs to pay the ECB’s interest rate of 1.75%.

But why stop there? Once this line has been crossed, the sky is the limit, and only explicit action from the ECB could stop it. Given that Germany is likely outvoted on the ECB governing board, it seems unlikely that the ECB would veto.

Two forms of ECB abuse suggest themselves:

1) Instead of borrowing from the markets, just borrow from BFA instead. All the government needs to do is inject a sufficient number of bonds to periodically recapitalize BFA. Since BFA can access the ECB, effectively the government can borrow at the ECB’s 1.75% without regard to the markets.

2) Put a 10 trillion euros bond into BFA. Deposit it at the ECB overnight at 0.25% interest. Pocket 25 billion of free money and pay it back to the government as a dividend.

I suppose #2 would be the thermonuclear option.

If the Germans are not completely retarded, they would realize that a pan-European bank bailout scheme (together with a treaty change, perhaps banning government owned banks from abusing the ECB) is a much better idea.