By Jose Pineiro
Date: Wednesday 20 Jun 2012
At the G20 summit in Mexico, Spanish Prime Minister Mariano Rajoy criticised the effect that the bailout of the Spanish banking sector has had on Spain's sovereign bond yields. As such, Spaniards may have a hard time overlooking the fact that Rajoy touted the bailout of the Spanish banking sector as a victory during a press conference at home. Nor did Rajoy do anything to prevent public debt from being on the hook for bank bailouts.
Although the details of the bailout must still be ironed out, Rajoy told reporters at that local conference that it would not burden taxpayers nor would it come with conditions for the government. Those were bold statements and simply not true unless he is able to get the European Union (EU) to make those concessions. At a time when his credibility is ailing, these are issues that must have been addressed when speaking to the Spanish public.
Rajoy is losing political support as he fails to uphold earlier promises. An explanation of the virtues and downsides to the Spanish bank bailout would have greatly helped his case and credibility. Instead, he raised scepticism by refusing to label the plan as a "bailout" or a "rescue" and opting to praise it as a "credit line" that he championed himself by "pressuring" the EU. Rajoy's criticism of the bailout at the G20 leads one to question who did the pressuring.
To be fair, Rajoy has been calling for European Union (EU) funds to be used directly to recapitalise banks and thus prevent Spain's public debt from being on the hook. But it is unlikely that he will prevent funds from being channeled through Spain's Fund for Orderly Bank Restructuring (FROB). The European Commission already stated that the direct recapitalisation of banks would go against EU treaties. It would have to be allowed as part of a larger "fiscal pact" that takes the European Union towards a fiscal or banking union.
Breaking the “banking risk – sovereign risk” link
At the G20 summit, Rajoy insisted on the need "to break the link between risk in the banking sector and sovereign risk" in order to prevent the effect that the bank bailout is having on sovereign bonds. Breaking that link would be a big accomplishment in this debt crisis although Rajoy's sole reasoning is that it will prevent Spanish sovereign debt yields from rising. Both the "banking risk – sovereign risk" link and the "banking sector - real economy" link have placed the global economy in a chokehold because banking, government, and real economy are so intertwined that one cannot progress without the other.
The economy is held hostage by banks that are not sufficiently capitalised to get credit flowing. “There is a vicious circle in which governments are called on to support their banks with funds, damaging their own credit rating. Then their banks in turn spend those funds on their country’s sovereign debt in order to support the government’s rising borrowing costs," explained Digital Look analyst Jason Martin. This link will not be broken as long as governments continue to support "too big to fail" institutions, mostly banks.
People’s Party criticises bank liquidation comments
Ironically, even though Rajoy is asking the EU to break the "banking risk - sovereign risk" link, he and most other policy makers are not taking any action along those lines. Bank closures must be allowed in order to break that link but Rajoy is reluctant to even address the potential liquidation of banks, evident by last week's criticism of comments made by European Commission's Competition Commissioner Joaquin Almunia.
In an interview with Reuters last Wednesday, Almunia suggested that Spain would have to liquidate one of its three nationalised banks, namely NovaCaixaGalicia, CatalunyaCaixa or Banco de Valencia. The FROB, in charge of recapitalising and restructuring Spain's troubled banks, quickly issued an announcement on Thursday to deny that it had any plans to liquidate any of the banks under its administrative control.
Almunia's comments have upset Spain's People Party (PP), prompting some to call for his resignation. Almunia belongs to Spain's opposition Socialist party and several PP members blamed him for going against his own country's best interests. Some saw in his words a hidden agenda to help the Socialist party.
"If he wants to lead the frustrated opposition, he should come here to Spain and dispute Rubalcaba head-on for the party's leadership," said Rafael Hernando, a Congress spokesperson.
Reading further into the interview, Almunia was actually explaining that bank liquidation might in some cases be a cheaper alternative to a taxpayer bailout.
Due to the controversy that ensued, Rajoy met with Almunia on Friday. One might assume that Rajoy asked Almunia to tone down his statements in order to diminish the risk of spooking the markets. Instead of asking for his resignation, Rajoy may have realised that it is best to have a fellow country man on his side within the EU.
Rajoy, like most government leaders, may fear the repercussions of a bank liquidation but that option must be kept open in order to unwind the banking sector’s grip on sovereign risk. If the government is always there to bail out a bank, then by definition public debt will be on the hook.
We can be assured that the topic of bank liquidation will resurface. The option of bank liquidation may easily become one of the conditions for the EU’s bailout of Spain’s banking sector and a pre-condition before the bank – sovereign risk link that Rajoy looks to end is finally broken.
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