If I owe you a thousand dollars and can’t pay, I have a problem. But if I owe you a million bucks and can’t pay, you have a problem.
That’s the logic behind the deal brewing between Spain and Germany. Spain’s banks are overextended and undercapitalized, an artifact of a real-estate boom and bust that was especially sharp. The risk that systemic bank failure in Spain could trigger financial contagion across Europe is real. A run on Spanish banks could easily trigger a run on all European financial institutions.
The problem is that Spain’s banks are too big as a percentage of its economy for the Spanish government to support by itself. Even though Spain’s government finances are fairly sound, with a debt-to-GDP level lower than Germany’s, its private debt is excessive, so the the combined public/private ratio is over 280%, half again that of Germany. In Germany there was no housing boom, and no bust—unlike the rest of Europe.
And therein lies the rub. Spain’s economy is too big to fail, and too big to steamroll. Policy makers are prepared for a Greek exit from the Euro, but no such provision has been made for Spain. While emergency funds are available, Spanish officials don’t want to take a formal bail-out that would come with fiscal strings and the stigma that attended Greece, Portugal, and Ireland.
So Spain is pushing for direct help to its banks, something the Germans don’t want to do. Cross-border bailouts are fraught with unintended consequences. But some sort of compromise will come—because if Spain owes Germany a trillion Euros, Germany has a problem.
Douglas R. Tengdin, CFA
Chief Investment Officer
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