In Europe, Spain is expected to formally apply for a Troika bailout in November. Despite the Rajoy’s government’s denials that it has not sought a bailout, Rajoy and his ministers have never specifically said that they refused to consider a bailout. In fact, it is commonly believed that the Rajoy government is negotiating the terms of a bailout right now and is waiting until November before a finalised plan is unveiled. To wit, the latest informtion from government sources says Rajoy is requesting an explicit target spread backstop from the ECB.
According to the ECB’s new OMT plan, new bailouts in the euro zone will be managed by the Troika of the EC, ECB and the IMF with the European Stability Mechanism acting as the mechanism through which the bailout occurs. The ESM will buy any Spanish bonds at auction which are not bought by private investors, making up for any shortfall of private sector demand for Spanish bonds at auction given Spain’s funding needs. The European Central Bank will then buy bonds on the secondary market in unlimited quantities in order to assure that the bond yields at auction remain low.
The question I posed last Tuesday was about how this gets accomplished. Specifically, I wrote: “Portugal will be forced into an ECB monetization scheme. Their present program will end and yields will still be too elevated for Portugal to access capital markets without ECB help. The question here is how Portugal gets its 2- to 3-year bonds into the market at a reasonable rate. Does the ECB have to set an explicit target in the secondary market to support this? That is a first ratcheting we need to consider in the ECB’s new monetization scheme.”
And we see now that this is the problem for all bailouts under the OMT program because El Pais is reporting that the Spanish government want an explicit target of 200 basis points – and this is exactly why it has not asked for a bailout already:
The government wants to obtain assurances that the European Central Bank (ECB) will intervene in the secondary market to ensure that the risk premium for Spanish bonds comes down to approximately 200 points and remains at that level. The absence of such guarantees is the source of the doubts Mariano Rajoy has in not asking for a rescue, according to government sources, which deny that imminent Basque and Galician elections (October 21) and subsequent Catalan elections (November 25) are at issue. They also reject the notion that German Chancellor, Angela Merkel, is pressing for a delay in Spain so she can submit it to Parliament in a single package with aid to Cyprus and an extension granted to Greece.
The government says 200 points represents a “reasonable” bond spread between Spanish and German 10-year bonds, given the economic situation of both countries, and alleges that levels above emanate from the uncertainty surrounding the survival of the euro. At the same time, the government estimated that a 200 point spread in Spanish debt would be sustainable and that the Treasury could meet funding needs in the medium term, even without a rescue. Spanish spreads closed Friday at 417 points and reached 638 last July, a level to which they could escalate again, and even exceed, if ECB intervention is definitely cast aside.
I believe this story is very credible and I take it as the likely story in terms of the how and why of a Spanish bailout given my prior question of how the OMT bailout will work for Portugal. There will be a lot more to come in the coming days and weeks.
Source: El Mundo
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