I’ve lost count of how many crisis weekends we have faced, How many summits we have had that are about to change the nature of the problem, but we are at another one of those moments, with the added joy of bank stress test releases coming out of Spain.
The Bull Case
I had turned bearish on the situation in Europe last week, which had worked well until yesterday. I remain bearish, but there is an obvious and possibly realistic path for the bulls.
1) Spain, followed by Italy ask for and receive OMT and ESM support. The terms of which are generous.
2) Spanish bank recap goes ahead.
3) Budgets work, economies show signs of rebounding and markets reach new highs.
That is the bull case in a nutshell, and I had believed in it for awhile, but don’t see anything working out quite smoothly.
The ECB and IMF are in a tricky situation as the IMF has to at least appear to be impartial and devising a plan that can work. Germany and Finland are the most outspoken about demanding real conditionality. The IMF’s reputation is down because of Greece, so not fulfilling their role here would hurt further. In this case it isn’t IMF money (so not China or the US cash) but they need to make a realistic effort. That is in the face of technocrat Monti saying on Bloomberg that the IMF shouldn’t be involved in setting the conditionality.
I think they will largely agree that the Spanish budget as announced yesterday is all the conditionality that is needed. On the surface, a major win for Draghi and Rajoy. But this is where I expect the first snags. They won’t be given years to meet the terms, there will be quarterly reviews. They will insist the 43 planned laws get passed. They will monitor progress. Without such strict ongoing “maintenance” requirements, the fiscally prudent countries would be up in arms.
But that means Spain would have to enact the laws rather than saying they plan to enact them – a big difference given the mood of the Spanish people. We can all applaud the efforts yesterday, but even if everything they said gets enacted, I find it hard to believe targets will be met. The propensity to overestimate revenue increases while underestimating economic deterioration has been a common theme in European sovereign accounting from the start. So whether by riot, or by basic math, the likelihood of long term support based on original conditions is unlikely.
Given the speed with which Europe moves, it is likely that Spain will break conditionality before the first bond is purchased.
If the budget fiction wasn’t entertaining enough, today we get the sequel, Spanish Bank Stress Tests.
The last ones were beyond comical. Asides from whimsical valuations, they applied excess reserves at good banks against losses at bad banks – not exactly how it works in the real world.
Personally I would like to see a big number, 100 billion, and the conclusion that multiple banks would fail. It would show they were serious. Then FROB could take the promised 100 billion and get to work on recapitalizing the banking system. I would also like to see the Buffalo Bills win the super bowl, and I’m not likely to see that any time soon.
What we are likely to get is some politically acceptable number in terms of loss and some absurd conclusion that almost all the banks are safe as is and will be pristine with just a little capital. I have no clue why there is such a string tendency to play things this way, but there has been.
If we get this minimal number, rather than expecting markets to react positively in relief, expect weakness as everyone will know they will be back at the table in a few months asking or more.
If we see a real commitment to inject massive amounts of money into a bank recap I would be encouraged. It would finally put banks back on a footing where they might be able to help the economy. Maybe I will be pleasantly surprised, If it is some small number designed to save existing shareholders and management than any pop will be sold.
I’m not a Keynesian but I find it hard to believe that much of what was discussed yesterday will provide the results that are called for. I see the economies continuing to deteriorate in the face of budget cuts, with the real possibility that Spain will bog down in a series of demonstrations and regional politics will further weaken the country. It seems all to clear to me that being against bailouts is an ever increasingly sure way to garner support and politicians will use that.
With the delays since the original OMT announcement, the growing anti-Euro movements across Europe, and the total failure to quickly implement plans to impact the real economy, I think we get scared again. Green shoots or brotes verdes may eventually be seen in Europe, but nothing about the likely scenarios says anything real is happening soon on the real economy front.
So I am still bearish, and will watch for cues as to whether this time is different in Europe. If they meet some of my conditions, I’m prepared to change my view, but for now, I have this sinking feeling that none of the ideas will be long lasting enough to have an impact.
And if you are bored of Europe you can try to make sense of the now daily 2% swings in Apple.