The Spanish Bail-in. Huh?

Sometime between attending the high school graduation party for the son of one of my high school classmates, and waiting for the temperature to drop a little so I might mow the lawn in comfort, I spent an hour reading more about this weekend’s Spanish bank bailout.

But before I comment on that…  I have to say that, in the event gray hair doesn’t make one conscious of his age, attending a graduation party for the offspring of a peer will remedy that in short order!   That, and finding out, at that same party, that Bruce Springsteen signed his initial recording contract 40 years ago this week.

I tried to rationalize my feelings by recalling a line from a song by Jethro Tull:  “You’re never too old to rock and roll.”  Then someone pointed out that the song was released 36 years ago.

Back to Spain.  In the hour I had allotted to reading, I read a piece by DeutcheBank detailing how the Spanish bailout would work within the framework of the existing Euro-zone treaties.  I also read an analysis of the weekend’s events written by Bruce Krasting.  Finally, I hopped over to Bloomberg to look at the equity market futures and the EUR/USD exchange rates.  What follows are my observations in no particular order:

  • As of this writing, the Euro has strengthened by 1.02% over the USD.  Forex seems to think the bailout has legs.
  • US stock futures (DJIA) were up 141 points.  The bulls are back.
  • The Nikkei Index is trading up 60 points while Singapore has thus far added 38 points to its index.
  • Other markets have yet to open.

All-in-all, the weekend’s developments have brought back evidence of the “animal spirits.”

I hope the rally truly has legs and the bailout is a meaningful step towards removing the Sword of Damocles that has hung over the market’s head for the past 5 years.  But here’s the problem.  It’s not a bailout.  Having read the documents (the DB doc in particular since it referenced this term twice), what is occurring is known as a bail-in.  A bail-in!  Sounds nice.

The thing about a bail-in, is that it really is (as is known in bankruptcy parlance) a cramdown.   I mean, if someone came up to me and asked if I’d rather be “bailed-in” or “crammed down, ” my gut would say “Bail me in!”

But they are one in the same.  And this is where the Krasting article makes its finest point.

In a bail-in (or cramdown), positions in the capital structure that had previously been senior get “crammed down” into subordinate positions.  Spanish bank loans that were subordinate only to the actual depositor’s money will likely be moved to the third position, as the bailout loans take the second spot – essentially cramming down the senior loan holders.  Sorry, I mean bailing them in.

On the surface, that sounds dandy.  The bondholders knew the risks when they bought the bonds, so knocking them down a notch in the capital structure is fair and just.

Kind of.

If you wanted to be fair and just, the entire capital structure all the way up to, but not including, depositor accounts should be wiped out until the bank has adequate capital.  That’s a different argument to be made another time.

But we live in a world of unintended consequences.  We presently have the luxury of witnessing these consequences much more frequently, since governments can’t seem to take their hands of the knobs for even a second.

My reticence about this bail-in, is that senior bank loan holders in other countries (like Italy, France, and maybe even Germany) might decide that it’s too risky to hold these loans.  Should things go poorly in those countries, might they be bailed-in too?  Could fear of this (unintended consequence) create mass liquidation of senior loans in Europe, akin to those we saw in the US in 1998 (you could buy $1 worth of senior floating bank debt for about $0.50 at the time)?

If I were long the senior loans of banks in the above-mentioned countries, it would certainly give me something to consider.

But…  I’m not long those loans, and it looks like it’s time to cut some grass.

This has been my 3rd blog in as many days, and I thank you for your indulgence.  I find living in this period of history to be fascinating.  And I enjoy sharing that enthusiasm via the blog.  What strikes me as funny, though, is through all the troubling big-picture discussions, there are still parties where we celebrate fine young men graduating from high school.  And weed-riddled grass that needs to be mowed.  It’s that small-picture stuff that makes life so enjoyable.

Whether or not some Spanish bank is getting bailed-in.

PIGS at the Trough


It was announced today that the world now has porcine in the plural.

Portugal, Ireland, Greece, and now Spain.

After a contentious phone conference among the EU’s muckety-mucks, Spain will receive $125 billion in loans to shore up the capital in their banks.  Spain’s economy minister, Luis de Guindos, announced that the loans (coming from the EFSF, and not from the IMF) will be added to Spain’s bailout fund, then pushed into the failing banking system.  While initial estimates of the size of the Spanish bank-hole were around $60 billion, The EFSF wanted to over-promise in order to bring confidence back into the system.  “Going forward, it will be critical to communicate clearly the strategy for providing a credible backstop for capital shortfalls — a backstop that experience shows it is better to overestimate than underestimate, ” said Ceyla Pazarbasioglu, deputy director of the IMF’s monetary and capital markets department (as well as the winner in the “Impossible to Pronounce Name” contest).

But here’s the thing (or things).  From the beginning, Spain has never been clear (or truthful) on the capital needs of their banks.  Take the recently nationalized Bankia, for example.  On May 21, Bankia was nationalized by Spain to plug the 4.5 billion Euro hole in its capital.  By May 23 that figure had risen to 9 billion Euro.  The following day the number rose to 15 billion Euro.  By the 27th, when all was said and done, the total bailout was 19 billion Euro.  I’d hate to apply that same kind of exponential math to the $60 billion number being thrown around today!

Further, there is the issue of the cajas.  Basically these are Spanish savings and loans.  A bunch of them were failing and subsequently were bundled up to become the bank known as Bankia.  Even more of them, however, are still walking the Spanish landscape like so many George Romero extras at the mall.  Being highly unregulated, these cajas made many, many sub-prime (and worse) loans during the inflating of the Spanish real estate bubble.  This isn’t merely speculation.  To wit, I refer you back to the founding of Bankia.  No clear number that I can find totals the bad loans buried within the cajas.  And if someone knows, they ain’t talkin’.

The bright side to all of this is that Spain, who was effectively cut out of the bond market, can now borrow at sub-market rates from the EFSF.  Also, the lack of IMF participation leaves the American taxpayer out of the lending syndicate.  It’s also likely to be short-term bullish for stocks (and bearish for US bonds).

That is, until the markets decide that bad news is actually… well… bad.

I have to think we’re getting awfully close to that point.

Saving Spain’s banks may have been necessary, but the act of saving them screams to just how bad the European situation has become.

To conclude with a quote from Ben Bernanke at this week’s Congressional hearing, “a trillion here and a trillion there and pretty soon your talking about real money.”


Eurozone “Resolution” Gooses Equities and the Euro

In the wee hours of the morning, Euro zone leaders arrived at a deal that pushed the European sovereign crisis back from the precipice — if only by a few feet. The basics of the deal are as follows:

  • Private banks and insurers will accept a “voluntary” loss of 50% on their Greek government bond holdings. Public institutions will not share in the haircut.
  • This haircut will reduce Greece’s debt burden by 100 billion euros, and will drop their projected debt to GDP ration to 120% by 2020
  • Holders of CDS are now holding worthless paper, as the “voluntary” nature of the haircut avoids a technical default upon which the CDS would have paid out. There’s a lesson for those pesky speculators.
  • The Euro zone will provide 30 billion Euro’s of credit enhancements to the private sector as an incentive for them to accept the “voluntary” haircut.
  • The 250 billion Euro’s left in the EFSF will be levered into 1 Trillion Euros in the form of either offering insurance or some form of an SPV (Special Purpose Vehicle).
  • On the news, the DJIA rallied over 300 points and the Euro/USD has traded up over 1.42.

Far be it from me to curse a good tailwind, but I think it pays to remain skeptical, if not dubious.

According to Bloomberg, the “tag along” effects have already begun as Ireland is now sniffing at the handout trough. Further, this new levered structure reminds me an awfully lot of the structure of the mono-line insurance companies — and we all know how well things worked out in for them in 2008. But, for the time being, impending doom has been reduced to delayed discomfort.

It reminds me of something I read about being hanged. From The Flexible Bullet: “You may wonder about long-term solutions; I assure you there are none. Take what’s given. You sometimes get a little slack in the rope but the rope always has an end. So what. Bless the slack and don’t waste time cursing the drop. A grateful heart knows that in the end we all swing.”

Hopefully Europe will use the slack this move has provided to arrive at a more permanent, believable solution. Otherwise, we may all swing.

Acronym Deja Vu

I just want to make sure I understand today’s European bailout rumor/plan correctly…

First, the European Financial Stability Fund (EFSF) will construct a Special Purpose Vehicle (SPV)

Next, all the European sovereigns with pre-default debt will place their toxic paper into the SPV.

Then, the SPV will issue bonds back to the same pre-default sovereign nations.  These bonds will be rated as investment grade.

Finally, the pre-default sovereigns (PIIGS) will use their freshly minted investment grade bonds to borrow at favorable rates from the European Central Bank (ECB), to recapitalize their banks.

Maybe I’m having deja vu all over again (with all appropriate props to Yogi Berra).

Only the last time, instead of EFSF, SPV, PIGGS, and ECB the acronyms were MBS, CDO, CMO, and TARP.  The track record of blending together massive volumes of toxic debt, slicing and dicing it, and having investment grade debt come out the other side is a little less than stellar.

But, hey.  The rumor/plan was worth a couple percentage points on the major stock market averages.  A few more acronyms and we’re likely to have a bull market on our hands!