Turmoil in the markets. Answers to foreign correspondents

With the news that Spain´s risk premium today reached 550 points and bond yields are above 7%, we need some quick comments/thoughts from you on this.

 Specifically:

1. Do these figures mean a sovereign bailout for Spain is needed?
2. Or do you think this is normal – i.e. the markets have acted in an exaggerated way to Moody´s downgrade, and will soon calm down
3. Everyone is now looking at Germany for a solution. Is this realistic? Can Germany – or even Brussels – really do anything?
4. What will be the consequences for Europe if a sovereign bailout of Spain happens?

ANSWERS

Overall answer to the current turmoil in the debt markets

They current turmoil in the debt markets is a consequence of three factors:

a)    Lack of action or lack of detailed action by the European authorities.

b)    Increased perception of risk (uncertainty) among investor that could produce over reaction, sometimes foolish.

c)    Negative impact of sensationalist news, absent of data that influence the public and the markets.

Specific answers to the questions

1.    Do these figures mean a sovereign bailout for Spain is needed?

•  Not necessarily. The rescue or bail out occurs when nobody lends money to a Government and then the Government has to rely on funds provided by the EU. It also occurs when the interest rate to pay is prohibitive. 7% is not!. 
• So far the Spanish Gov has covered all the bond issues reasonably well. 
• The total cost of the debt for the Spanish Government is on average 4%, or 32 billion which is a 7% of the public budget… not that much. https://blog.iese.edu/martinezabascal/2011/11/30/prima-de-riesgo-y-coste-de-la-deuda/

 2.    Or do you think this is normal – i.e. the markets have acted in an exaggerated way to Moody´s downgrade, and will soon calm down

• Spain has similar figures to UK in terms of public deficit, public debt, lack of economic growth. It had also similar house bubble and problems with banks.

https://blog.iese.edu/martinezabascal/2012/04/18/deuda-publica-de-espana-y-de-otros-paises/

https://blog.iese.edu/martinezabascal/2012/06/06/deudas-y-activos-de-las-familias/

https://blog.iese.edu/martinezabascal/2012/04/13/deuda-de-espana-y-otros-paises/

https://blog.iese.edu/martinezabascal/2012/02/28/se-merece-uk-un-rating-de-aaa/

 

See Category Deuda Pública in the blog. There are many short posts with data.

• But the reaction of the markets towards Spain or Italy vs. UK has been very different. https://blog.iese.edu/martinezabascal/2011/11/11/italia-vs-uk/
• Markets are made up of people, with feelings, euphoria and depression, even panic. Don’t be surprised if they go up to heaven or down to hell in a matter of days. It is prudent to hear the voice of the markets to understand what they feel, but don’t follow them closely.

https://blog.iese.edu/martinezabascal/2012/06/12/no-presten-atencion-a-los-analistas/

https://blog.iese.edu/martinezabascal/2011/07/28/cuidado-con-los-mercados/

 

3.    Everyone is now looking at Germany for a solution. Is this realistic? Can Germany – or even Brussels – really do anything?

•  The main problem of Europe is the lack of economic action. See article on how the USA reacted to the crisis and why the lack of action in Europe.

https://blog.iese.edu/martinezabascal/2012/03/27/como-remonto-ee-uu/

•  The lack of action of Europe is explained by three factors.

–       There are three government entities that have the executive power: European Council, European Commission, Council of the EU… to many entities to take quick and effective action.

https://blog.iese.edu/martinezabascal/2012/06/07/mas-europa-pero-que-alguien-mande/

–       National interest still play an important role. Europeans are not convinced the whole is greater than the sum of the parts

–       Germany plays “the” crucial role. Ms. Merkel is victim of her prejudices. https://blog.iese.edu/martinezabascal/2012/05/14/porque-europa-no-actua/

 

4.    What will be the consequences for Europe if a sovereign bailout of Spain happens?

•  Unpredictable, which means even more uncertainty… more risk which means all the markets down.
• If Spain falls the next will be Italy
• The stampede effect is well known among the market practitioners. You have to stop the crowd before the stampede starts, when the stamped occurs the effects are devastating…. and they could have been avoided easily… with appropriate, effective and tough action.