Spanish Banks are getting bailed out…so why is everyone so gloomy? It seems that after two years of bailout after bailout, market participants have finally realized that one cannot escape indebtedness by borrowing more money. It is hard to believe it took this long for investors to figure that out, but then again it seems that politicians and even some economists are still having trouble with this concept.
It is possible that this latest bailout has made obvious the unholy alliance between big banks and big government. Make no mistake, this €100 billion bailout was targeted for Spain, not Spanish banks. Multiple times over the last several weeks the Spanish government has warned that they were being cut off from the financial markets and would no longer be able to borrow money. The solution: prop up Spanish banks so they in turn can continue to loan money to the Spanish government.
It is a vicious cycle. Governments have only two choices for collecting revenues: they can tax their citizens or borrow the money, and most of the borrowing comes from financial institutions. Under normal circumstances with manageable debt levels this is not an issue, but as the debt levels get out of control, as they have in Europe, fewer and fewer investors are going to be willing to loan money, and if they do they are going to demand higher and higher interest payments to justify the risk. The exception is big banks that have a dual relationship with the government. The government is a large client, as they have loaned much of their capital to the government, and the government is their boss as they regulate the banks. One can see where conflicts may arise.
Suddenly in Europe the call is for a Europe-wide banking union. Why? Because market participants are starting to figure out that most of Europe’s banking problems are from the fact that the banks have loaned money to various European governments. Sure there are real estate losses in Spain and Ireland, but the biggest issues throughout Europe are related to sovereign debt. The solution to banks being in trouble is for the government to come in and back-stop the banks. So follow this: the banks are in trouble because they have loaned too much money to the government that is in debt way over its head, and the solution is for the government to bail them out? Increasingly this is looking ridiculous to anyone who is actually paying attention.
This brings us to Herbert Stein’s Law: “If something cannot go on forever, it will stop.” Debtors, including governments, will hit a point when lenders simply stop lending them money. The problem is that it is next to impossible to know exactly when one will reach that point. So while it is a good thing that Spanish banks are being bailed out, avoiding that tipping point for Spain, the market sees that nothing really seems to be learned. Every step in this crisis has been about Europe’s leaders looking to find more money to borrow instead of fixing the problem. Eventually Europe must live within its means and start reducing debt instead of adding to it. The current situation cannot go on forever and therefore will stop. The question is: does it stop voluntarily with European governments making difficult grown-up decisions, or does it stop by force when there is nothing left to borrow? The former would be less painful, but thus far the latter looks more probable.
Chuck Osborne, CFA