Citizens of the South, fear the ESM

Spain got its first bailout on Friday, as many people had been preaching for years now. A bailout that was to be avoided at all costs by the Spanish government and, once accepted, is not referred to as a bailout, leading to international mockery (see You say Tomato, I say bailout, Details Emerge About Spain's Cramming Down "Bailout" Loan). 100 bn WOW! It is a big deal, way bigger than the Spanish people would be able to swallow, and has incidentally coincided with the weekend of Italy-Spain Euro 2012 match. Good stuff to distract the populace.

The money goes to the FROB (Bank Ordered Bailout Fund). Part of the bailout comes from the EFSF (now) and another from the ESM (when established in July), which does not compute as deficit.

We need to focus on the seniority status of the debt incurred when bailed out by the ESM. Senior debt means that debt with that status takes priority over any other debt. The problem with this type of aid is that it leaves Spanish bond holders in a secondary place when paying. I believe that the tensions on the Spanish sovereign debt will not relax since international bond investors know that they will come second to the ESM and there will be little if nothing left for them to take in case of problems. As per Wikipedia page on ESM:

Critics have noted that the ESM severely confines the economic sovereignty of its member states and criticise that it provides extensive powers and immunity to the board of ESM Governors without parliamentary influence or control.

But there might be more to it. The EU may be withholding information as to what their final goal is. Simply ask yourself the following question: If the market asks for a 6% yield on the 10Y and the rescue package comes at a 3%, where is the catch? Their intention is not just saving the banks (their true intention). Otherwise this operation would have been carried out avoiding the State-owned FROB and using more standard ECB financing instruments such as LTRO. Why not make an adjustment operation with Spanish banks, or open a third window of liquidity at 1% and with larger balance-sheet flexibility?

My advice to young Spaniards is to look for opportunities overseas starting today.

Furthermore, Bankia, an entity that has capital and reserves of 10,000 million and losses (assets less liabilities) of at least 40,000 million has a market value 4 billion. New financial engineering all over again. How did it come to this? Mortgages for everybody, overratings, avoidance of risk aversion models, impossible targets, fierce competition between branches, bonuses... Some insiders knew the system would ultimately fail simply because they did not care where they were going to. 

The financial system is short-term and with the deregulation, managerial incompetence, it is even more short-term. In addition, bank management was full of inept and corrupt politicians. Finally, it is shielded (too big to fail). With 12 million hostages, including depositors, and current account holders, you get what you want. 30,000 million, for instance. This is how things are and there is nothing left to do. We keep talking about financial system reforms and bank bail outs and say that some country "has been bailed out", but essentially we keep having the same financial system and the same government and regulators that favored the elements that led to this situation.

The only think we can do is try to laugh at it