Spain is finally getting a bailout and, naturally, we’re already busy at playing our depressing small-minded games about how to call it, who can we point the fingers at, etc. How productive. Sigh. The Prime Minister is going to be ridiculed for a few weeks for his refusal to call a spade a spade. Rightfully so.
Of course it is a bailout, a rescue. It is also enormously different from the previous European bailouts of Greece, Ireland and Portugal. These other countries are embarked in what the EFSF terminology calls “macro-economic adjustment programmes”. Their bailouts include funding of the general government financing needs and, in exchange, set wide-ranging conditions that the bailed-out country needs to adhere to. These include budgetary measures, structural reforms (pensions, labor, competitiveness, etc.) size of the public sector, etc. The Spanish bailout is different.
The details known so far (which are few) follow, to the letter, what was public information since July 2011 in the form of this EFSF Document: Guideline on Recapitalisation of Financial Institutions (FIs) via loans to non-programme countries.
This document clearly states:
The objective of the new instrument is to provide financing to Member States in order to specifically support financial institutions against appropriate conditionality, i.e. not necessarily in the context of a macro-economic adjustment programme but under another more focused form of conditionality.
The focus of the EFSF funded support should be on financial sector repair, with planned restructuring/resolution of financial institutions as the sine qua non condition for EFSF assistance for recapitalisation.
There are essentially two sets of conditions:
- EU-related institution-specific conditionality: Basically, this means that all EU existing regulations about state-aid have to be followed. There’s also a provision that foresees including additional conditionality stemming from an eventual European-level banking resolution regulation/authority.
- Horizontal conditionality (financial sector reform): Financial supervision, corporate governance and domestic laws relating to restructuring/resolution (also inline with upcoming regulations at the European level).
Well, so far so good. This financial assistance programme does not include broad-spectrum macro-economic conditionality. Is the Spanish government “no strings attached” spin true? Not completely, alas.
That same document, when describing the eligibility requirements for a country to be able to access the programme, explains:
Countries under excessive deficit procedure would still be eligible for this recapitalisation loan, provided they fully abide by the various Council decisions and recommendations aiming at ensuring a smooth and accelerated correction of their excessive deficit.
Spain is, indeed, under an excessive deficit procedure. This means that getting into this bailout turns what were before mere “recommendations” into hard requirements. Now, were we going to follow on those recommendations regardless of being bailed out or not? Quite possibly, but we will now be mandated to do so.
And what are those recommendations? Well, there will be more in the future, to be sure, but as of now, these have already been published by the European Council after analyzing Spain’s Stability Programme Update 2012-2015:
- Deliver an annual average structural fiscal effort of above 1.5% of GDP over the period 2010-13 (…) Establish an independent fiscal institution to provide analysis, advice and monitor fiscal policy, as well as to estimate the budgetary impact of proposed legislation.
- Accelerate the increase in the statutory retirement age and the introduction of the sustainability factor foreseen in the recent pension reform (…)
- (…) address the low VAT revenue ratio by broadening the tax base for VAT. Ensure less tax-induced bias towards indebtedness and home-ownership
- (…) addressing the situation of remaining weak institutions, (…) comprehensive strategy to deal effectively with the legacy assets (…) and define a clear stance on the funding and use of backstop facilities.
- (…) take additional measures to increase the effectiveness of active labour market policies.
- Review spending priorities and reallocate funds to support (…) SMEs, research, innovation and young people. Implement the Youth Action Plan.
- Take specific measures to counter poverty, by making child support more effective and improving the employability of vulnerable groups.
- Take additional measures to open up professional services (…), reduce delays in obtaining business licences and eliminate barriers to doing business. Complete the electricity and gas interconnections with neighbouring countries and address the electricity tariff deficit in a comprehensive way (…)
All these things we must now implement. Most of the items on the list are measures we were going to be cajoled into doing anyway. If this looks like comprehensive macro-economic conditionality to you, I have a bridge in Brooklyn to sell you. You just need to look at the reactions of our neighbors in Portugal and Ireland to see if they believe we’ve gotten a similarly conditioned bailout as theirs.
There are still a lot of missing details, of course. In fact, Spain hasn’t even requested the bailout yet. Last Saturday’s Eurogroup meeting consisted in Spain announcing that it will formally request the bailout soon and the rest of the members stating that they’re willing to grant it:
The Eurogroup has been informed that the Spanish authorities will present a formal request shortly and is willing to respond favourably to such a request.
Anyway, they’ve also put a nice big round figure on the sticker to add some strength into this anticipated statement: €100 billion. Keep in mind that this is just a limit on the total amount that the different European rescue facilities. Spain most probably won’t be asking for that much money. I’d be frankly surprised if we end up tapping more than €55-60bn out of the credit line.
Another important issue is that of seniority. An unwelcome effect of these bailouts is that when there’re many preferred creditors, non-preferred investors tend to be crowded out. The situation is this:
- IMF loans are super-senior to anything else. Thankfully, IMF won’t be contributing funds to the Spanish rescue. (IMF direct involvement would also trigger troika visits and all that men-in-black juicy stuff)
- EFSF (European Financial Stability Facility) loans are pari passu (equal to others) respect to existing senior debt.
- ESM (European Stability Mechanism, to become operational on July 1st 2012) loans are senior to all others except FMI loans.
What has been reported in the news is that Spain will probably be getting funds from both EFSF and ESM. This would mean that part of the loans (those coming from ESM) are, in fact, senior to outstanding public debt. But there’s an important catch. The treaty establishing ESM states:
In the event of ESM financial assistance in the form of ESM loans following a European financial assistance programme existing at the time of the signature of this Treaty, the ESM will enjoy the same seniority as all other loans and obligations of the beneficiary ESM Member, with the exception of the IMF loans.
As you can see, it is extremely important that Spain taps at least some funds from EFSF before requesting any loans from ESM if Spain is to maintain direct access to debt markets. There’s no guarantee we will retain access to the markets even in that case though, but it will be easier.
There has also been a lot of discussion (and a lot of dumb statements) about who is the actual recipient of the funds, who guarantees that the loans will be paid back, who provides the money, etc. Here’s a small FAQ on all that:
- Who gets the money? The Spanish Fund for Orderly Bank Restructuring (FROB), which is a government agency with the full backing of the Spanish Treasury as a guarantee.
- Who guarantees that the loans will be paid back? The Kingdom of Spain. Not the banks.
- Who provides the funds? In the case of EFSF Willing investors. Not “the Dutch taxpayer”. What our fantastic neighboring taxpayers provide here are guarantees, not funds. ESM will have a mix of paid-in capital (“taxpayer money”) and issuance capacity (getting funds from investors).
- So banks do get the money for free? Not exactly. FROB won’t be gifting money to the banks. It will become an owner of them (total or partial). Hopefully, this is a position that FROB will unwind sometime in the future and get back the money that was injected into the banks (or at the very least a good chunk of it). Part of the recapitalization for banks will come in the form of direct equity and part will come in the form of contingent convertibles (CoCos). This is already the way FROB works.
About the funding mechanism, theory indicates that EFSF/ESM issue debt in the markets and transfer the funds to the bailed-out country. However, there’s also the possibility, regarded by the stuffy chaps at the Financial Times as “highly unorthodox” when Spain itself floated the idea a few days ago, of directly providing the recipient with EFSF/ESM bonds. At the end of the day, capital is capital. The fact that many people who should know better mistake capital and liquidity all the time doesn’t change reality. For liquidity assistance you can go to ECB or other liquidity providing facilities (repo markets, etc.).
A big unknown, let’s keep in mind that Spain has still not formally asked for the rescue, is what will the interest rate be and the maturity profile of the loans. We’ll see, but my guess is that they will be significantly lower than what Spain pays now in the markets. Which leads me to the last point I want to address: Impact on the deficit. Everybody in Spain asks about this. Even to our disastrously clueless Prime Minister. “Does this
rescue bailout convenient line of credit affect the public deficit figure?”
Yes, it does. Naturally, the principal amount of the loans won’t be included in the deficit figures (as long as it is clearly justified that these are purely financial transactions as required by ESA95 III.2.1). But the interest payments on the loans are, of course, public spending and thus have an impact on deficit figures. About wether the impact is positive or negative, it depends on what reference you take for the comparison: no bailout and no bank rescue? impact is indeed negative; no bailout and bank rescue anyway? impact is in this case positive because the funds (and interest payments) are much cheaper. The specific details on how the capital will be injected into the banks play a role here. CoCos pay a coupon to FROB that detracts from deficit (in 2011 FROB got more than €700 million in payments from outstanding convertible bonds). There are rumors that the loan could have a 3% rate and 15 years maturity with no payments in the first 5 years. Mr Almunia has stated that banks receiving CoCos will pay an 8.5% coupon. If this is finally the case, the measure could be significantly positive for the public deficit figure (i.e. reduce it).
In any case, this is all still very preliminary. We are in for some interesting weeks.