Moral Hazard of Bailouts

Spain Says No ‘Urgency’ to Seek Bailout as ECB Eases Yields – Bloomberg.

Spain Says No ‘Urgency’ to Seek Bailout as ECB Eases Yields – Bloomberg.

The Northern countries keep insisting on conditionality to bailout cash, and today’s comments by Spanish politicians succinctly show why they are correct. Let’s look at a chart of Spain’s decreasing bond yields over the past few months:

Historical Data Chart

Note the large decreases in fits and starts since Draghi told us that he would do whatever it takes to save the Euro in July.  What is important about this chart is that it shows that while yields have been decreasing, nothing has changed.

I realize that the ESM has jumped over its last hurdle and that the ECB has pledged to monetize the short-term debt of countries requesting a bailout. These initiatives are virtually meaningless, because the fundamentals have not changed.

To wit, Spain is now backing off seeking a bailout and is locked in a dangerous game of chicken with Europe:

Every country that has requested a bailout has thrown the party doing the requesting out of office. The problem with the bailout is not the free money from Germany; it is those pesky austerity conditions. What the promise of external help has done is remove the immediate reason, rising interest rates for its debt, for Rajoy’s government to pursue deeper cuts and to seek a bailout.

If you examine Spain’s current fiscal position, you will see that Spain cannot meet its financing needs for the rest of the year without external help:

But there’s more. Spain is still in the midst of a depression caused by the bursting of its housing bubble. Housing prices have not even hit bottom yet. Unemployment is around 25%, and the economy is still shrinking. The entire banking system is going to need a bailout. Indeed, things have changed in the last few months; they have actually gotten worse.

In the spirit of self-preservation, I think that Rajoy will stick to his guns. Europe needs Spain to request a bailout as much as Spain does. His goal is to get bailout cash without the humiliation of having to sign a memorandum of understanding effectively ending his government.

If he could pull this off, it would be quite the coup. Of course, this action would also stoke resentment in the countries that have already gone through austerity and troika inspections. What will the reaction be in Greece, Portugal and Ireland if Spain gets it way?


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