Spain’s funding needs, regional debt and public pension raids

Spain had an estimated 350 billion euros of debt that it needed to roll over in the three years from 2011 according to analysts at Brockhouse Capital. Add in the likely need to fund regional government deficits and rollovers as well as the need to recapitalise banks as the housing market continues to decline and you see the fundamental problem for Spain.

My concern with Spain is liquidity more than solvency. Given the deflationary policy path, the high private debt levels that create higher private savings and the debt rollover, you are guaranteed to have gargantuan funding needs during a period of high deficits. For any currency user, this is a recipe for a liquidity crisis. Right now, Spain is looking good because the yields have subsided after the OMT program was put in place by the ECB. But the fundamental liquidity problems are still there. And as the funding schedule ramps up, I expect it to become an acute problem, causing Spain to seek a bailout.

The Wall Street Journal points out today that Spain’s funding from private sector sources has been reduced by the government’s use of the pension kitty. They expect this to end shortly.

Spain has been quietly tapping the country’s richest piggy bank, the Social Security Reserve Fund, as a buyer of last resort for Spanish government bonds, raising questions about the fund’s role as guarantor of future pension payouts.

Now the scarcely noticed borrowing spree, carried out amid a prolonged economic crisis, is about to end, because there is little left to take. At least 90% of the €65 billion ($85.7 billion) fund has been invested in increasingly risky Spanish debt, according to official figures, and the government has begun withdrawing cash for emergency payments.

lAthough the trend has drawn little public attention or controversy, it has become a matter of concern for the relatively few independent financial analysts who study the fund, which is used to guarantee future payments of pensions. They say the government will soon have one less recourse to finance itself as it faces another year of recession and painful austerity measures to close a big budget deficit.

I am not thrilled with the hyperbolic language the Wall Street Journal uses. They call Spanish debt “risky”. They describe the public pension fund reserve as a “piggy bank”. And they say that the social security fund is a “buyer of last resort”. These are loaded words used to promote an ideological framing that has parallels in the US with America’s own social security fund that is used as a “piggy bank” and “buyer of last resort” to ‘fund’ American government deficit spending. I think this bears noting because the language struck me as so hyperbolic. Those who share the same ideological bent may note notice the manipulative non-neutral framing of the issue.

The reality here is that public pension funds almost ALWAYS buy ONLY their government’s bonds.  I can think of a notable exception like Chile. However, in most countries this is the norm. So there is nothing unusual about this situation in Spain whatsoever. What is unusual – or at least pertinent to Spain’s funding needs – is that Spain has been withdrawing cash from the pension fund for emergency funding and this withdrawal has reached its legal limits. So what is pertinent here is not the ideological question of the morality of large deficits and the use of public pension money, but rather that the Spanish government’s source of funding will change.

My thesis for 2013 is that the Spanish government will continue to have high deficits as private deleveraging continues, resulting via sectoral balances in public sector deficits. I believe these deficits will be viewed negatively by private sector buyers of Spanish debt and that a situational trigger will cause a renewed increase in Spanish bond yields. The trigger is unknown; it could be an unexpectedly large round of capital injections needed for Spanish banks or a crisis in the regional governments of Catalonia or Madrid. I don’t know what the trigger will be. But I expect any significant untoward macroeconomic event that affects the Spanish government’s deficit, debt and funding needs to trigger a re-evaluation of the risk of Spanish sovereign bonds. I also expect this re-evaluation to impact Italy. This is going to be a main theme for me in 2013 as far as the euro zone goes. So I will keep you abreast on these developments as time proceeds.