Wednesday, 6 June 2012

The pain in Spain remains firmly ingrained…



In September last year I wrote 'Without the contingent liabilities of their banking systems Spain and Italy (the elephants in the zone) would inspire a lot more confidence from the bond markets' whilst describing the appeal of a broader EU or EZ recapitalisation of troubled banks. 

Recapitalisation is done through making investments. The terms on which the investments are made provide a mechanism for the banking sector to refund its saviours directly. Thus if surplus countries (such as Germany, Finland etc) need to recapitalise Spanish banks, their investments could be made on terms which provide the creditors with an economic rate of return.  Some form of contingent convertible or bail-in bonds would be an appropriate structure (bonds which pay a high level of income and don’t dilute investors until losses are very severe, in which case ownership of the bank is gradually ceded to creditors).

These securities also provide the banks with a window in which to recapitalise themselves through retained earnings, disposals etc – which seems a fair way of balancing the interests of shareholders and management against those of the customers and lenders.

No such action took place but now the Spanish are desperately agitating for a recapitalisation fund.

Concerns exist about the form it can take as the legal establishment of the EFSF precludes it from being used for this purpose.  Fortunately it could be used to lend to the Spanish government which can then use the funds to recapitalise the banking system.

So a solution therefore is at hand? But German officials remind Spain that they would have to make a formal request for the funds. Why? Do they just want to be asked nicely?

In Spanish eyes the formal request route is sinister.  It would also heap more liabilities on the Spanish state and would require Spain to follow an EU/IMF mandated package of austerity measures.  While the measures would likely be those already being imposed voluntarily, politically governments find it easier to justify implementing reforms because they believe they are right, rather than doing so because they were told to.

Themes we have picked up on before continue to dominate the story of the eurozone.  Policy decisions tend to be “only just enough and only just in time” and every opportunity to deprive the electorate of their democratic power seems to be seized upon.

Such actions are extremely short-sighted given the political instability being witnessed in Greece.  Policy makers have to find ways of making interventions appear mutually beneficial rather than intensely confrontational and recapitalisation on a quasi-commercial basis offers a way.

Guy Foster
Head of Portfolio Strategy

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