The Spanish government’s credit rating is teetering on the brink of junk status and it seems destined to follow Greece and Cyprus down the default route
A lead article in this week’s Economist asked the question: Where’s the next Lehman?
My answer to the Economist’s question is: Spain is the next Lehman. The European Central Bank’s upcoming Asset Quality Review (this winter) will reveal a number of insolvent banks that require recapitalisation. Moody's already rates seven Spanish banks below investment grade.
Financing the recapitalisations shouldn’t pose a problem, because Spain still has a €50bn credit line from the European Stability Mechanism. The ESM gives Spain the money, and they use it to recap the bad banks. Problem solved.
The problem would be solved were it not for the eurozone’s new ‘no bailout principle’, which requires ‘bailing in’ creditors prior to the disbursement of ESM funds. In other words, the banks must default before they can be recapitalised.
It is conceivable that a bail-in could be conducted in such a way that depositors, counterparties and interbank lenders would be protected. If so, it would be very helpful if the Troika could make such an announcement now, rather than waiting for the inevitable funding crisis this winter.
If no such reassurances are given, rational actors will further reduce their exposure to weak Spanish banks. Presumably this funding could be replaced with funds from the ECB, but that is not a path to viability.
I would add that the Spanish government’s rating is teetering on the brink of junk status. It is now rated Baa3/Negative Outlook. Moody’s observes: ‘We would consider downgrading Spain in the event of an inability to implement the fiscal and structural reforms that are aimed at stabilising its debt burden, and/or in the event of a loss of access to private markets.’
Spain will stabilise its debt burden the same way that Greece and Cyprus did: default.
Christopher T Mahoney is a former vice chairman of Moody’s. This post first appeared on his Capitalism and Freedom Blog
