ESM Fund Already Exhausted

Spain tops agenda for euro zone permanent bailout fund | Reuters.

Let’s make an assumption to start: the ESM actually has €500bn in “firepower.” Be wary whenever the language of war is being used by a government, because this language is actually bullshit.

In war, you downplay your strength when you are strong in order to lull your enemy to sleep before an attack. When you are weak, you exaggerate your strength to dissuade your enemy from attacking.

Leading up to D-Day, Allied forces were hidden all over England prior to the attack. Germany believed that the Allies were several months away from being able to muster an invasion force.

Germany had big problems facing Russia on the Eastern front and could not afford a proper defense of the Norman coast. All over Normandy, there were fake gun nests, fortifications and even whole headquarters constructed of wood and unmanned to give the illusion of strength.

History has a funny way of repeating itself. Germany and its allies do not have the financial strength to bail out the continent, so they have prevaricated and presented a serious of illusions.

The latest is the ESM. Basically, the ESM’s capital includes contributions from members like Spain that need to be bailed out, but we are going to take eurozone’s word and pretend that €500bn is available.

Spain wipes out that entire amount by itself. The mainstream media refuses to report real numbers and relies on the garbage spewing from the Spanish Finance Ministry.

Spain’s banks will need much more than €60bn to recapitalize themselves.  Spain reported that bad loans rose to €172bn in the latest quarter, and this number does not tell the whole story. Look at Spain’s housing bubble, the source of all of these bad loans. The blue line is Spain, the grey line is the US for comparison:

Spanish housing prices still have a way to fall, and Spanish banks still have to write down a lot of associated loans. Furthermore, we know that bad loans are being under-reported by Spanish banks, because this is what banks do when they are failing. A conservative figure I heard is that 25% of Spanish banking systems €1.7tr in loans are bad. That’s €425bn in bad loans. This capital hole will need to be filled as part of a bailout.

The banks are still in trouble. Spain has been experiencing a bank jog for over a year bleeding 5% in August. The ECB has already lent €412bn to Spanish banks to plug this gaping hole in their balance sheets. The banks are out of assets to pledge to the ECB for more cash. Any deposit flight will have to be added to the cost of a bank bailout. Let’s say another 5%  leaves before the bailout, a very conservative figure because that’s just one month’s worth; you need to add 5% of €1.5tr to bank bailout costs. That’s €75 + €425bn for an even €500bn, and we haven’t even bailed out the government.

Since we have already used up the whole fund, anything that the government needs will need to be part of supplemental funding for the ESM. Germany and the northern tier countries will have to ram more spending through their parliaments. In the meantime, investors seeing that there is no money left will start the mother of all runs on the sovereign debt of the rest of the periphery and the soft-core of Belgium and France.

One thing that I have learned from the eurocrisis is that a dying system can take a surprisingly long time to actually die. Eventually, when something cannot go on, it will stop.

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