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/

The European Fiscal Tourniquet

  Last year, in the midst of the Greek meltdown and Portugal's problems, the Germans {rightly} insisted that EU states take decisive measures to balance their budgets. On January 31st of this year, the EU agreed on what was called the European Fiscal Compact. This agreement makes it so that EU nations would be forced to balance their budgets by 1/1/14.

* This would have to be ensconed into the member states' constitutions.
* The treaty demands that an automatic correction mechanism be enacted in their constitutions.
* All states would accept the jurisdiction of the Court of Justice to verify the imposition of this rule.
* It requires all states balance their budgets by January 1st, 2014.
* The EU's High Court will be able to fine any nation that does not accept a balanced budget amendment in it's constitution. 
* Any nation which does not ratify this into it's constitution will be ineligible for any aid from the ESM.
* The treaty will enter into force if by January 1st, 2013 twelve of the seventeen EU states ratify the treaty.

So far, only Greece has ratified it oddly enough. Portugal, Poland and Slovenia have all passed it in one of their legislative houses, awaiting passage in the other one. Ireland is holding a referendum on May 31st on this treaty, and as of this writing it looks like it has a good chance of passage. I actually believe it will pass in time. It will be quite interesting to see if France will pass this with the election of Hollande. If this treaty does not pass, Germany will have it's excuse to head for the exits.

  This treaty presents several problems. First and foremost it ensures that the countries in trouble will be forced to apply another deflationary tourniquet to an already constricting economy. Greece's recent example of what deflation can do should be a huge red flag for these nations. For nations like Spain, it will ultimately be forced into a brutal political choice come late 2013-- exit the Euro or apply the tourniquet {assuming they ratify this. If not, then no ESM rescue and a bond crisis hits them very quickly}Other nations like Italy, Portugal and Ireland will also face this brutal choice. Some will do neither-- their governments will fall apart. I'd wager that more than one nation will end up like Greece and Belgium-- essentially without a government that can make a decision. This is not what markets want to hear. These adrift nations's bonds will be immediately punished by the markets, presenting a crisis almost immediately should a nation {for whatever reason} be unable to balance its budget. Damned if you do, damned if you don't. 

Spanish Meltdown & European Elections

  Yesterday elections in France and Greece brought new governments to power with different ideas on how to tackle their respective economic problems. In France, Francois Hollande, the Socialist candidate, came to power with the idea of increasing taxes on the wealthy and pushing the ECB into greater purchases of sovereign debt. The idea of pushing the ECB to purchase more sovereign debt would, in theory, weaken the Euro currency as ECB purchases amount to little more than printing money and loaning it to governments. This idea is vehemently opposed by Germany, who does'nt want to see their hard earned savings devalued and their loans to other EU nations monetized away. Angela Merkel openly supported Sarkozy, something she probably will come to regret. Hollande also promised a balanced budget by 2017, lower the retirement age to 60, and to hire 60,000 new teachers as well as increase taxes on those making more than a million per year from the current 46% to an absurd 75%. Sorry Mssr Hollande, but expanding the welfare state and raising taxes isn't going to work in a world where French businesses {and investors} can simply uproot and relocate to other nations who choose not to ruthlessly punish their success. Why would anybody start a business there with this mentality ? Answer: They won't.  They'll start their business in Poland or Ireland.

  In Greece, the two pro-bailout parties {Pasok and New Democracy} together got 149 seats in their Parliament. You need 151 at least to form a government, therefore they would need to get another of the anti-bailout parties on board. This afternoon, the New Democracy leader announced that he was unable to form a government. Next up is an anti-bailout leftist party's {Syriza} turn to try and form a government. This is unlikely to happen as they would need to get an ultra right party on board-- thats rather like Stalin asking Hitler to share Poland, and we all know how that ended. The most likely outcome is another election in a month or so, and in the meantime there will simply be no government. I'm not so sure this is all too bad; at least the crickets can't make anything worse than the politicians did. Will the next election produce a clear result ? Probably not. Oh well-- Belgium has been with out a government for a few years. Yeah this will end well. 

  Moving along to another socialist catastrophe, Spain today put out some economic numbers that were truly scary, even for a nation already used to Depression-era statistics. "The interannual variation of the Industrial Production Index for the month of March was -10.4%" and this was followed by "The Spanish service sector declined from 46.2 in March to 42.1 in April", which is a decline of nearly 10%. In a month. This is what can only be termed an implosion. All of those newly unemployed will be applying for government benefits-- from a government teetering on bankruptcy and who, thanks to the aforementioned economic decline, will have even fewer revenues to pay them with and will thus have to borrow even more. The Spanish Gov't is also going to bail out one of their big banks, Bankia, costing them from $8-11 billion. If I was the Spanish PM, I'd have turned sheet white and taken to heavy drink by noon. Not that it would matter much; there's probably little he can do now that the ship has struck the iceberg. Yeah this will end well. Short the Euro, folks.