Bankia, Spain and the Euro Zone

Bankia in Spain has become the next institution to require a bailout in the euro zone, and as is now a familiar pattern, Bankia has been declared too big to fail. 40 billion are needed immediately, and 80 billion eventually. The IMF has already suggested that the money simply has to be spent, and reassured markets that a bailout will be coming. European finance ministers meet next. This is the last in a series of moves to use the money reserved for public bailouts for private institutions.

What Bankia does, beyond costing the EU a great deal of money, is call into question the quality of stress testing at the European Banking Authority. as the EBA says itself, the information is provided by the banks themselves:

"We have to remind you that this is a bottom up exercise, conducted by the banks in most cases using their own internal models. The estimates of risk parameters by banks are sometimes very diverse, also for exposures in the same portfolio and against counterparties in the same country. Although the EBA took action to achieve greater consistency and more rigorous estimates. More work on this issue is needed in the future."

Although the last round of stress testing revealed a high concentration of undercapitalisation at Spanish banks, Bankia was not considered one of the banks worthy of regular review (which you would expect of  banks that are too big to fail). The banks reviewed can be seen at the end of the EBA's last stress test review for 2011.

Spain gets it right again

Spain has proven once more adept at reading the signs of an attack and going on the offensive. As everyone closes around Greece and France, Spain has passed a balanced budget amendment to its constitution. I expect it will do better than otherwise possible in the turbulence that is coming up this month and next. Indeed, with Spain's lower overall spending profile, the adjustment should hurt less than it does elsewhere.

It's not that budget retrenchment is objectively necessary, especially for Spain, with its low public debt. Nor is it that the current hysteria about deficit reduction is somehow right in treating Spain the same way as Greece or Portugal. Instead, the objectively good reason to move is that markets collectively are sloshing in a huge wave around Europe and don't really care about economic fundamentals any more. They care about political signals like this that identify a country as one of the winners.

Spain has decided it's going to come out of this crisis even stronger than it started. With such a big wave coming, whilst other countries are looking at it and wondering whether they can swim, Spain has just pulled out a surfboard. 

They may just pull it off. Whether it works or not, you've got to admire the balls behind that move.

The Pain in Spain

has been bad enough these past three years without the curse of being associated with Portugal. The Spanish may have floated their economy on a credit-fuelled real estate boom during the last decade, but they have managed to fulfil the budget criteria for EMU membership for most of that time. Whereas Italy, Greece and Portugal only managed to enter the single currency with what was generously depicted as creative accounting, Spain demonstrated the steel and determination to bring down inflation, reduce unemployment and keep public finances on an even keel.You can read more about it here, in my book. It's only problem was moving too quickly to be sustainable.

Spain's principal problem is that international investors and European politicians don't distinguish between Spain and Portugal. When the original list of member states was being drawn up in 1998, Spain almost didn't make the cut despite doing its homework because of Portuguese problems rather than questions of its own merit. And the same problem is happening today. No one is entirely sure what toxic ooze lurks within the depths of Spain's mammoth banks, but there are good reasons to view Spain and Portugal differently. The most important is the political will and capacity of the Spanish to sort out inflation and public finances.

Today, late on a Friday evening, the Spanish government contacted me directly to let me know about a new statistical website they are setting up to inform people about their performance. The fact that there is a Portuguese election on Sunday is no accident in my estimation, and the Spanish are reacting appropriately. No matter what happens, election results have a way of unmasking the true face of public opinion and public demands. Portugal is going through the most unpleasant period of its young democratic history, and the resentment and frustration against discipline that contributes to Portugal's status as the poorer of the Iberian sisters is likely to be confirmed. That will typically lead to investor sell-offs and capital flight.

Spain's legitimate interest now is to convince investors as best it can that Spain is not Portugal. That is not only a good thing for Spain, but a good thing for Europe if it succeeds. That message needs reinforcement from other European governments, who must make a clear distinction between Spain and its western neighbour and underline that it's based on facts and a reputation for discipline. Spain will fight the good fight, but it will need help to deter an attack.

Or the first run on a major euro zone country will not be far off.