Spain's Problems Mount

  This week was a bad one for the EU and Spain in particular. First off, the cost of the bailout of Bankia just keeps going up. It began as a $4 billion bailout, then $8 billion-- and by late Friday had morphed into $24 billion. While not enormous, lets remember that the Fed's backdoor bailout of Bear Stearns cost $35 billion. For Spain however, this is a pretty big bailout-- especially coming on the heels of the really bad economic reports coming out of Madrid showing the economy actually declining. We're not sure where this will end either.

  On Wednesday as the Summit in Brussels was going on, Spanish PM Rajoy strongly urged that the ECB be allowed to step in and purchase sovereign debt, saying that their economy can't take much higher rates. Part of the problem on this was the last solution-- the last two LTRO's have loaded Spanish banks with Spanish government debt. When the value of this massive pile of debt goes down, the banks take losses. Last week, the value of these bonds went down, costing not only the Spanish state more money to service its debt but it's banks as well in these losses.

  Out in the real world in which we all live, Friday afternoons are very much looked forward to. In the financial world, it is just the opposite-- Friday afternoons after market close is when companies and nations unload their really bad news, which at this point is actually expected. Unfortunately for Spain, the Governor of it's biggest state, Catalonia, could'nt wait until market close to crap all over the markets. He announced that his state would need help from the central Spanish government to meets its obligations as Catalonia was essentially now shut out of the bond markets. Catalonia will need help in finding about $16 billion or so. The Spanish 10 year Bond immediately tanked, leaving Spains banks with even more losses thanks to the aforementioned LTRO, nevermind the Catalan State Bonds, which also tanked, producing another flood of red ink at these very same Spanish banks. All of this is happening in a nation who's unemployment rate is now 24% and who's economy is actually contracting.

  When {not if} Spain goes under, the EU banking system will be in serious danger of collapsing. In the meantime, don't be surprised to see Rajoy's request that the ECB begin purchases materialize or even another LTRO, of which there were market rumors last week. Another LTRO will simply enable overleveraged Spanish banks to borrow money and use it to purchase even more unstable Catalan and Spanish Gov't debt. The noose is tightening and the stool underneath is looking less steady.

Update Mon 5/28 1pm: Ambrose Evans today in his blog mentions that Spain's newspaper El Mundo is reporting that Spain no longer has the power to bring down rates on their 10 year bond. Today it went up sharply to 6.47%. One problem with this is that the 10yr Bond is now 4.5% above Germany's Bund, and when you get to this point, a market trading group called LCH, which determines what margins should be on all commodities, raises the margin on you to trade this commodity. This amounts to a margin call on all those who are long the Spanish 10 year. This is the point where many traders simply give up-- and they sell the Spanish 10 year, this exaserbating the problem. Ambrose also mentions that Spanish PM Rajoy has accepted the inevitability of a bailout. We're entering dangerous ground here. Don't be surprised to see the ECB step in and quietly purchase Spanish debt. Here's a link to Ambrose's blog: http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100017477/spain-runs-out-of-money/