Is Germany Preparing for a Spanish Default?

Hope persists that Germany would not only bail out Spain and the rest of the Eurozone but would also tolerate the Fed-ization of the European Central Bank. Even Treasury Secretary Tim Geithner was hounding German Finance Minister Wolfgang Schäuble, who was on vacation like the rest of Europe. And yet, Deutsche Bank, Germany’s de-facto vice-ministry of finance whose CEO serves as éminence grise behind elected officials and bureaucrats alike, well, that venerable institution at the core of Germany Inc. appears to be closing the book on Spain.

And it’s Spain everyone is worried about. Not Greece. Which appears to have become a fait accompli. Even with Geithner. After his meetings with Schäuble and ECB President Mario Draghi, Geithner called Spanish Economy Minister Luis de Guindos. According to “sources of the Spanish government,” they tossed around solutions to stabilize the Eurozone and resolve the debt crisis that is ravaging Spain and Italy. Not a word about Greece. It has fallen off the agenda.

Spain is suffering from stratospheric unemployment, banks on life support, a moribund economy, and bankrupt autonomous regions. One of them, Catalonia, announced it would not be able to pay hospitals, schools, social organizations, child care centers, etc., public and private, for contracts they have with the government. The noose tightens.

So a week ago, de Guindos met with “el todopoderoso Wolfgang Schaüble,” the almighty Schäuble, as El País calls him (including the umlaut on the wrong vowel), to work something out. It’s urgent. Spain will run out of money in October unless it can raise enough to cover the bonds that are coming due, pay for its ongoing deficit, and bail out its regions. But it doesn’t want to pay the elevated risk premium the market demands for its bonds, and it doesn’t want to ask for a bailout because it doesn’t want the Troika—the austerity jocks from the ECB, the EU, and the IMF—breathing down its neck and run the show, as they’ve done with such great success in Greece. Spain wants to keep its sovereignty and dignity. If nothing can be worked out, Spain would, according to government sources, default. That word made it into print. With immediate effect.

So the best solution on the Spanish wish list would be for the ECB or the bailout funds (the EFSF and later the ESM) to buy Spanish bonds, either in the secondary markets to force yields down, or directly, but without any bailout conditions—precisely what the German Bundesbank and the Ministry of Finance have vowed to oppose: bailouts would come with conditions, namely budget cuts and structural reforms.

Alas, as long as “el todopoderoso” Schäuble demands conditions, Spain won’t request a bailout. Not until the very last minute. A game of chicken, with default as consequence. Geithner was probably telling de Guindos to back off and request a formal bailout and get it over with as soon as possible to avoid a crisis whose effluent might drift across the Atlantic and seep into the shaky US economy. President Obama’s reelection would be at stake.

But then Deutsche Bank released its earnings. They weren’t pretty; 1,900 jobs would be cut. And ominously, the bank, which walks in lockstep with the German Ministry of Finance, had dumped 37% of the Spanish sovereign debt still remaining on its books. By the end of June, it only held €873 million, down from €1.4 billion three months earlier. A process that is likely to continue—now that default and October had appeared in the same paragraph in Spanish papers. And so the bank is walking away from Spain, in synch with el todopoderoso Schäuble’s rejection of Spain’s wish list.

Deutsche Bank isn’t the only one. Capital flight continues to set new records in Spain. According to the Bank of Spain’s just released Balance of Payments, €41.3 billion left the country in May, bringing the first five months of the year to €163 billion. Eleven consecutive months of declines! For a total of €259 billion. 21.6% of GDP. And those are the people who know best.

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  10 comments for “Is Germany Preparing for a Spanish Default?

  1. Draghi has an easy way to prod governments that drag their feet in getting bailed out: he can disallow the government's bonds as ECB collateral, forcing banks to pay a higher rate under the ELA. He just did this with Greece and he can do the same to Spain. The Troika can also continue to play chicken with Rajoy on the theory that the D word is a bluff. If somebody said "Pay me or I'll commit suicide!", I'd call his bluff. There is no way that Spain gets a free bailout. (And God only knows what it will cost to rescue all the bankrupt regions.)

  2. Jim Booth says:

    Another interesting article that confirms that europe is spinning apart rather than coming together. The fault at the heart of the Eurozone was known about when it was constucted but it was believed that crisis would force europe together and these differences would be overcome in the heat of a finacial meltdown. Instead this crisis is breeding mistrust and reopening old wounds. How long before spain barely gets a mention and all of the focus is on Italy?

  3. VerySeriousSam says:

    "Spain wants to keep its sovereignty and dignity"

    Sure. But if she wants money from aliens, she'll have to give up on one or the other wish.

  4. Ms. Anne Thrope says:

    This reminds me of the 'deal with the devil' made by the FF at the inception of the U.S. Slavery was more or less ignored & allowed to fester for 80 years before the corrupt Southern system led to the Civil War. Major problems ignored with 'can kicking' seem to be the way of the politician. Of course, the current nemesis is the overwhelming debt accrued by all Western nations post 1960's, both sovereign & private/consumer. Just like a bankruptcy (or at least pre-GM bankruptcies) these 'deals with the devil' just have to wash themselves out……sometimes with cataclysmic consequences. it's the price we pay for living a long-term lie.

  5. Richard Hill says:

    WR you mentioned "sovereignty and dignity" that is the key issue. One way would be to pay the Spanish civil servant salaries (and politicians) in Spanish bonds, denominated in Euros, interest bearing and redeemable in 30 years. This lets the civil servants keep their dignity. Obviously, if Spanish govt employees need to cash their bonds now, they would have to take a haircut. But, since the civil servants are the main beneficiaries of the debt building it is only fair. The alternative, as in Greece, is to just cut their pay, which destroys their dignity and brings them out into the streets.

  6. Wolf Richter says:

    Richard – great idea, paying people with bonds. It's been done. California paid contractors with IOUs in 2008, when it ran out of money. But they were redeemed after a few months, not 30 years. Well, don't get me started about CA.

  7. johnm33 says:

    Given the corruption in the eu body politic and the and the consequential patronage, which varies from state to state, it's never going to be in Germanys interest to bail out the euro enough to save it. Hopefully they've taken the time available to get their affairs in better order and will be able to weather the coming storm, since they cannot afford to prevent it. Reboot with more realism.

  8. Markar402 says:

    If Spain want to keep it's dignity and sovereignty, it needs to stop being a ward of the (EU)state and return to it's own currency and work on rebuilding it's economy, which is now in shambles.

  9. Annette howey says:

    Spain doesn't want any one looking at the books. The real estate loans (defunct) are well hidden.

  10. ironclaws says:

    The mentioning of default and October is actually quite credible when it is noted that the next public holiday in Spain to fall adjacent to a weekend is Spanish National Day – 12th October (Friday). This is significant as if Spain decides she wants to fix her sovereign debt issues by dropping out of the Euro without alerting the market by declaring a special public holiday in advance for the switch over, this is the last bank holiday weekend which exists in 2012. Most exit strategies rely on a bank holiday weekend in order to allow the banks time to implement the currency switch over – even though doing this in three days would be somewhat tight. That weekend would also be somewhat symbolic given the context of the national holiday. If Spain does not intend to do this, then this is a very good way of applying direct pressure in order to get resolution.

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