Spain, Portugal And A Virtuous Circle Of Bailouts
Posted by Parmy Olson
Human nature dictates that while it doesn’t always make financial sense to do business with our friends, we do it anyway. It’s why trade and finance links between Germany and Greece, or between Britain and Ireland led to the former country of each pair playing a large part in a Euro Zone-led bail-out of the other.
Expect the same from neighbours Spain and Portugal.
Spanish banks like Santander and BBVA hold more than 40% of the outstanding sovereign debt of Portugal (valued at about 60 billion euros), which carries an eye-wateringly high interest rate reflective of the risk that the county will default on some of its payments. Portugal’s prime minister on Tuesday denied, naturally, that his country didn’t need a bailout. Yet Portugal is almost certain to go the way of restructuring, and senior debt-holders across the border could also take unprecedented haircuts, which represents potential losses on their investments.
It’s unlikely that much will happen before Portugal’s presidential elections on Jan. 23, but in the meantime, euro zone financial authorities will make significant changes to the design and possibly the size of the 440 billion-euro European Financial Stability Facility, says Fernando Fernandez, economics professor at IE Business School in Madrid, who believes the facility will double in size once it is applied to Portugal, and will implement lower interest rates.
“The problem with the Irish and Greece packages was that the interest rate of the rescue was 7%,” says Fernandez. “That solved the liquidity problem, but not the solvency one.”
It’s widely believed that the international bond market has already priced in a bailout for Portugal, and despite official protestations Portugal will likely have to renegotiate the terms of debt that’s largely held by Spanish banks.
Portugal and Spain are also looking to the horizon to gauge how long and challenging it will be for both to tap back into the bond markets once this all blows over. The worse the haircuts are for creditors, the harder it will be to issue debt in the future.
A decisive factor in that is Spain and the extent to which its banks (remember the ones who are taking the fall for Portugal) need to be recapitalized. Ireland, a fellow euro zone peripheral that is also in trouble, has no major hidden liabilities left in its banking system, with pretty much everything now out in the open (as far as we know).
But the same can’t be said for Spain, and local media reports have suggested that Spanish banks may need as much as 50 billion euros in capital. That makes the case for Spanish sovereign debt restructuring (not just Portugal) more likely, says Fernandez.
If both countries restructure, their main creditors, which include major investing institutions like Fidelity and Citigroup along with central banks, will want to know two things: 1) Will they put in economic reforms in place that will help encourage GDP growth over the next couple of years? and 2) Will the Euro Zone learn its lesson and develop a long-term stability fund that makes these sort of credit defaults unlikely in the future?
If the big creditors are satisfied on both fronts, Portugal and Spain face an easier return to the bond markets for funding. If not, the recovery for both will be longer and harder. Financial negotiating has never been so important for both governments.