With the release of a draft Memorandum of Understanding for Spain, it appears that the EU may be preparing to protect senior bondholders of insolvent banks in Spain, just as they did in Ireland. My thoughts here.
Last night’s Euro group meeting failed to resolve any of the uncertainty about the ultimate liability for ESM bank recaps and provided a commitment to do nothing about it until September. My thoughts here.
Much of the reporting and instant commentary on the announcement of the deal involving EFSF\ESM funding for Spanish bank recapitalisation has focused on the idea that “Spain got a better deal than Ireland”. The principal points being cited are that the Spanish deal has “no conditionality” and there will be no visits from the troika.
This strikes me as a wrong-headed way to view the Spanish and Irish deals. At least for now, Spain is only borrowing to recapitalise its banks. And Spain must satisfy conditions relating to this programme. The Eurogroup statement on this has only just over a page of text so it’s not hard to find this:
the policy conditionality of the financial assistance should be focused on specific reforms targeting the financial sector, including restructuring plans in line with EU state-aid rules and horizontal structural reforms of the domestic financial sector.
Unlike Ireland, Spain is (for now at least) still borrowing from financial markets to fund its deficit. And Spain’s projected deficit for the year, at 6.4 percent, is about half the underlying deficit that Ireland was running in 2010. Because the EU and IMF were agreeing in 2010 to provide very large amounts of money to fund Irish budget deficits, it was hardly surprising that they insisted on being able to monitor how this deficit was closed.
Note also that the IMF are not involved in the Spanish deal, so there is no need for troika visits. Furthermore, Spain is already implementing an Excessive Deficit Procedure programme so any fiscal conditionality requested by Europe would just look the same as the current Spanish fiscal adjustment programme, making such conditionality redundant.
On RTE’s This Week today, the FT’s Peter Spiegel argued that Spain got a better deal than Ireland because it was banking debt that locked Ireland out of financial markets and a “banks only” deal (without troika monitoring of fiscal policy) would have been sufficient for Ireland. However, there is nothing about the way the current Spanish deal is being done that would have improved Ireland’s prospects of retaining access to sovereign bond markets in 2010.
The reason banking problems contributed to shutting Ireland out of the sovereign bond market is because bank-related losses were transferred onto the sovereign. The current Spanish deal is no different. The fact that the money is being loaned to the FROB does not mean the Spanish government doesn’t have direct responsibility for it. Again, it’s not hard to find this in the one-page statement.
The Eurogroup considers that the Fund for Orderly Bank Restructuring (F.R.O.B.), acting as agent of the Spanish government, could receive the funds and channel them to the financial institutions concerned. The Spanish government will retain the full responsibility of the financial assistance and will sign the MoU.
If, as was the case with Ireland, the FROB’s “investments” in Spanish banks turn out badly so it is unable to generate the funds to repay the EFSF\ESM loans, then the Spanish government must pay the money back. As with the Irish case, the burden of recapitalising insolvent banks or loss-making acquisitions of solvent banks will fall on Spanish citizens.
For this reason, this weekend’s announcement may well end up shutting Spain out of the sovereign bond market. And if the EU agrees to provide funding for Spanish budget deficits then more intense monitoring of fiscal developments (and other areas such as structural reforms) is likely to feature in a revised MoU, even if the fiscal targets will probably remain the same as the current EDP targets.
So there really is nothing in this deal that should make Irish people in any way jealous or resentful. In contrast, this “banks only” deal from EFSF or ESM possibly sets a precedent that would make the kind of retro-fitting of Ireland’s banking arrangements that I discussed here (acquisition of bank stakes and refinancing of promissory notes) more likely to happen. And that would be good news.