Spain tops agenda for euro zone permanent bailout fund

BRUSSELS Fri Oct 5, 2012 12:18pm EDT

A Spanish flag flutters in the wind in central Madrid September 24, 2012. REUTERS/Andrea Comas

A Spanish flag flutters in the wind in central Madrid September 24, 2012.

Credit: Reuters/Andrea Comas

Related Topics

BRUSSELS (Reuters) - Euro zone finance ministers will formally launch the euro zone's permanent, 500-billion-euro bailout fund on Monday, bolstering the single currency area's defenses against the sovereign debt crisis that is now threatening Spain.

The European Stability Mechanism (ESM) will be used to lend to distressed euro zone sovereigns in return for fiscal and structural reforms that put the economy of a country that lost investor trust back on track.

Euro zone finance ministers, who form the ESM's board of governors, will hold an inaugural meeting of the fund on Monday -- two years after the idea of setting up a permanent bailout mechanism for the euro zone was endorsed by EU leaders.

"The ESM will be able to operate as of Monday afternoon. It will formally exist and it will be operational," one euro zone official, linked to the ESM, said.

The fund's lending capacity will be based on 80 billion euros of paid-in capital and 620 billion of callable capital, against which the ESM will borrow money on the market to lend it on to governments cut off from sustainable market funding.

The first 32 billion of the paid-in capital will be supplied in October, giving the fund an immediate firepower of 200 billion euros. A further 32 billion will come next year, raising the lending capacity to 400 billion, and the final 16 billion in 2014, when the ESM will reach its full 500 billion capacity.

The ESM's first task will be to lend to Spain for the recapitalization of the banking sector, hit hard by a collapse of the real estate market. This is a program the ESM will inherit from the temporary fund, the European Financial Stability Facility (EFSF).

An independent assessment of Spanish banks' capital needs showed that under the worst scenario they would need to get almost 60 billion euros. But officials say the amount will likely to be closer to 40 billion as some of the needed capital would be provided privately or via bank restructuring.

ESM money would only flow to Spain in November, after the European Commission's competition authorities approve the details of the recapitalization for each bank.

Spain is the focus of investor attention now as the government struggles to deflate one of the euro zone's largest public deficits even as the country sinks deeper into its second recession in three years.

In Luxembourg, euro zone ministers will also discuss an expected request by the Spanish government for a precautionary credit line from the ESM that would allow for the issuance of first-loss guarantees on bonds sold by Spain at auction, or some similar form of rescue to bolster Madrid's credibility.

Guaranteeing the first 20-30 percent loss on new Spanish bonds would allow - through leveraging - all of Spain's 207 billion debt issuance in 2013 to be made much more attractive to investors using roughly 50 billion euros of euro zone money.

It would also open the way for buying of Spanish bonds on the secondary market by the European Central Bank -- a prospect that has lowered Spanish yields already from above 7 percent in July to below 6 percent now.

But Germany opposes a Spanish bailout request now, because it would prefer to bundle Spain with a request for a small, 15 billion euro bailout for Cyprus and a revision of the second, 130 billion euro bailout for Greece in one crisis-solving package later this year.

This would allow German Chancellor Angela Merkel, wary of shaky support for bailouts in her own ruling coalition, to push the large crisis package through parliament in one go, rather than fight separate battles for each.

As a result, a Spanish request is unlikely soon.

"I am quite confident that if it were to come, it is not imminent," one senior euro zone official with knowledge of the discussions on Spain said.

Spain's borrowing costs, measured by the benchmark 10-year bond yields are at 5.71 percent -- a level that Madrid cannot sustain for long, but which does not force it to seek help immediately.

"If you look at the current market situation, I see no need for Spain to apply for any program," the senior official said.

The ministers will also take stock of the efforts of Greece to unblock payments from the second bailout agreed in February after reforms in the debt-laden country stalled because of two general elections in May and June.

Inspectors representing international lenders are in talks with the Greek government on reforms and austerity needed to unlock financial aid, but their full report is unlikely before the end of October.

The lenders are represented by the International Monetary Fund, the European Commission and the European Central Bank -- also called the Troika.

One euro zone official said that Greece would be discussed in earnest only at the next Eurogroup meeting on November 12.

"The Troika is in Greece, Troika top representatives will be at the Eurogroup and will inform the ministers about the contentious issues and problems, they will describe state of play. I don't think there will be any milestone decisions," another euro zone official preparing the meeting said.

(Reporting By Jan Strupczewski; Editing by Toby Chopra)

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see
Comments (2)
Just another layer of bureaucracy that will create more debt that will be taxed to the public by the same murderers and robbers that created the need for it in the first place. Government is a domino effect.

Oct 05, 2012 12:52pm EDT  --  Report as abuse
dareconomics wrote:
ESM Fund Already Exhausted

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.

Oct 05, 2012 1:33pm EDT  --  Report as abuse
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.

Full focus