Money At The ECB Auctions
As reported on this blog at the end of last week, the European Central Bank lent a record 49.4 billion euros ($73.6 billion) to Spain's banks in July, with lending to Spain rising from 47.1 billion euros in June and 18 billion euros a year ago. This little data point now seems to be attracting rather a lot of interest, since Ambrose has a piece over at the Daily Telegraph, while the Wall Street Journal Blog adds its two cents worth.
The source of all the recent fuss is an interview which the President of the Dutch Central Bank Nout Wellink gave to the newspaper Financieele Dagblad (you can find a translation of the whole article by the US blogger Edward Harrison here).
So the knotty little problem of Spanish funding from the ECB is rearing its ugly head yet one more time. Personally my feeling is that this issue is being rather overblown at this point. Ambrose is scratching around in the right areas, but I think he doesn't fully understand the problem (see more below).
The point is that Spanish bank borrowing at this point is not that high PROPRORTIONATELY. Total ECB funding of eurozone banks is running at around 460 billion, so the Spanish banks are still only up to about 10.65%, which is not that much above their participation in ECB financing (the so called "key" -7.55%).
As all the authoritative commentators point out the Spanish banks are not standing out especially for their use of the ECB facility (although they have accelerated their recourse to this facility very rapidly since last August), and have mainly drawn according to the weight of their share in the eurozone itself. One explanation for the fact that they have not tried to obtain more (since I am sure they need it) may be found in statements made during the most recent appearance of Bank of Spain governor, Miguel A. Fernandez Ordoñez, before the Economy and Taxation Commission of the Spanish Congress. There he stated (June 24, p9) that Spanish banks have increased their participation in eurosystem fundings, "without going far beyond the equivalent participation in the key of Bank of Spain in ECB´s capital".
The rule they have been trying to apply is not to go much beyond the key subscription of the BoE to the ECB capital (which is 7.55%).
My feeling is that this situation is being policed as best they can by the Bank of Spain, and they are trying to hold a line, although obviously things are now starting to get out of hand, as witnessed by the latest months increase - up to 49.4 billion euros in July, from 47.1 billion euros in June - which edges them up just that little bit further beyond their participation share, and this is what is causing all the fuss. Clearly as Not Wellink suggests things can't go on like this.
Not Wellink is also clearly right when he says "If we see banks becoming very dependent on central banks, then we must push them to tap other sources of funding," but the problem is that the market will now demand a lot more from the Spanish Banks for refunding the cedulas, and this would mean that something legally would have to change in Spain to enable the banks to charge ALL their customers significantly more than the small surcharge over euribor-one-year they currently receive to be able to service the refinance. And this "small change" in the mortgage regulations is obviously something the Spanish government can't face up to politically.
The principal point about the Spanish use of the ECB facility is not so much the quantity, as who it is that is doing the borrowing. If it is - as the Daily Telegraph suggests - mainly small regional cajas, then this is even more serious. It is more serious since normally you would expect the Spanish banks to go in convoy, and the big ones help the little ones. But as we have been seeing on this blog, even rather large entities like Caja Madrid and Banco Popular are themselves now having problems, and thus the big fish no longer have the liquidity themselves to help the small ones. I would take it that this is the real problem, and that the money being sought at the ECB auctions is only the tip of the iceberg.
Basically the Spanish banking system has a problem just as large in its way as the FannyMae and FreddyMac one, since they have 300 billion euros or so in ceduas hipotecarias to refinance over the next 5 years (not counting all the other RMBS's which are knocking about, which have equal or greater value, even if the term on these may not present the same sort of problem), starting with 40 billion or so this autumn.
But Spain has no Hank Paulson with his bazooka to come to the rescue. And as we can see in the US arming up the bazooka can simply make its use unavoidable, and this is obviously what the unnamed source behind this Daily Telegraph quote was obviously getting at:
"Nobody dares pinpoint the country involved because as soon as we do it will cause a market reaction and lead to a meltdown for the banks"
But all of this is, unfortunately, now more or less inevitable.
Incidentally, despite what Ambrose says, the ECB money isn't precisely taxpayers money at this point. They are simply making loans from the resources they have via the reserves deposited with them through the eurozone banking system, and they have some money of their own via seinorage, I guess. And they are lending it, not giving it. The point at issue is simply that they are accepting what are really junk bond status cedulas as if they had investment grade, with the helpful support at this point of rating agencies like Moody's who at the same time deny this status to much more sustainable debt in places like India, Brazil and Peru.
But even the ratings agencies are now getting nervous, and are busily working their way through numerous trances of debt issued by the Spanish banks conduits - Santander's Hipotecario 4, Caja Madrid's RMBS III FTA etc - and indeed, as the WSJ article notes, many Spanish banks are now only able to get a rating from a single agency on their new issues (which often go straight to the ECB) while previously it was standard parctice to have two.
So the question we really need to face up to is: who is the Brussels equivalent of Hank Paulson, and just when is he or she going to arm up the bazooka, because the Spanish banking system - just like FannyMae and FreddyMac - is going to need a substantial re-capitalisation, if not outright nationalisation, and the Spanish treasury does not have the resources for this alone. And don't miss the point that it may well be difficult for the Spanish treasury to guarantee bank deposits as happened in Germany (after 1995) and Japan (after 1992) or has happened recently in the UK in the case of Northern Rock, since under the terms of the cedulas if a bank fails the cedula holders have to be paid out in full before any depositor receives a penny (and maybe they even have access to the underlying asset, that's why the interest they carry was so cheap, they were meant to be watertight, just as safe as the best sovereign debt, just as safe as.... houses, and indeed, being realistic, they were expected to be even safer than Italian or Greek sovereign debt).
So compared to all this that is to come (plus other little memoranda items here and ther like the 30 billion euro debt of Ferrovial I was reporting on yesterday) the 49 billion euros currently outstanding at the ECB could be considered to be a mere trifle, and certainly only a warm up taster.
Now I said above I felt that Ambrose doesn't really understand the full extent of the current problem, and I think this is clear when he says the following:
"This "soft bail-out" is largely underwritten by German and North European taxpayers, though it is occurring in a surreptitious way."
My feeling is he is confusing two issue here, the current account deficit, and the problem of who is later going to pay for all the broken plates. Spain's CA deficit has been paid for basically up to now by savers in Germany, Holland and Finland (ie in those eurozone countries running CA surplues), but these savers - via their agents - now want to be paid more for the risk they are assuming, and this is at the heart of the present difficulty, since what Spain had to offer as a warranty to back the lending was property, and this property is in the process of a revaluation.
Indirectly this fininacing difficulty is showing up on the books of the ECB, since the banking system in these CA suplus countries is a net saver, and not a net borrower. At the same time of course, due to their recent housing boom, some Dutch banks need ECB help, even though the country itself runs a large net CA surplus (6.5% GDP 2007). So the issue is a complicated one.
I don't think taxpayers money from other countries is arriving in any direct form to the Spanish banks at this point. The theoretical issue is why some countries - Germany, Holland, Finland - have been running surpluses, while others - France, Ireland, Spain, Portugal, Greece - have been running deficits. (Of course the UK also has a CA deficit, but it is not in the eurozone, but this makes it hard to say that it is simply a "Latin" phenomenon).
EMU was posited on structural convergence taking place between countries. This is just not happening, and it is this absence of convergence, rather than the difficulties in applying a one size fits all monetary policy, that is really the big underlying issue. There are various possible explanations why countries are not converging, but one of my strong feelings is that demographic assymetries have a lot to do with the situation.
Back To the Cajas
So winding up this section on ECB finance and the Spanish banking system, why don't we go back to where we started:the regional cajas.The Spanish newspaper Expansion has an interesting article today (Spanish only I'm afraid)about the state of Spain's saving banks - the Cajas de Ahorro. Basically Expansion reports that a total of ten regional cajas have now seen the level of bad debts rise above the 2% mark, which is the quantity set aside by the Confederación Española de Cajas de Ahorros as the benchmark provision for this eventuality. As Expansion notes there is nothing especially alarming in this number when compared with levels prevailing in other countries, what is worrying is the rate of increase, since Spanish banks and cajas have traditionally had very low levels of loan defaults, and indeed while the ten savings banks now have a provisions ratio of under 100%, even as late as the end of 2007 the ratio for the whole group was 217%.
Expansion does not offer us a list of the ten main offenders, but it does say that of the 35 cajas who have reported to date on their first half performance, 11 have default levels above the 2% provision. Expansion also mentions that a number of the cajas were negatively affected by the entry in administration of Martinsa Fadesa, and mentions the example of Caja Sabadell where the default level has risen to 3.24% following the impact of Martinsa Fadesa.
Expansion also single out Caja España, who reported last Thursday, as the caja with the highest default ratio - 3.9% - among those who have reported so far. Caja España has doubled its provisions, but has still to give a figure for its cover ratio. Among the larger cajas Expansion single out Caja de Ahorros Mediterraneos (CAM) which has the lowest cover ratio (only 50.6%) followed by Caixa Catalunya with 91.7%. (Incidentally Expansion also reports that CAM shares have fallen 5% in the month since they started trading despite the fact that Lehmann Brothers - who arranged the float - have bought 1.3 million shares at a price of 5.64 euros each and significantly above the current market price of 5.55 euros). They also make the point that many Cajas are currently busy trying to "clean up" their books a bit as regards loan defaults by selling the loans off at a loss, a move which does not recover the full value of the debt, but technically moves the number out of the bad debts section of the accounts and directly into the profit and loss section.