So this is pretty suboptimal. Basically, what’s happening is that the new bonds that the Spanish government is issuing are increasingly just being bought by big Spanish banks rather than by international investors. Meanwhile, French and German investors are holding less and less Spanish bonds. (The same thing is happening in Greece, Portugal, Italy, and Ireland, but right now we’re worried about Spain because despite a concerted effort from the federal government, the regional governments, and the European Central Bank, the Spanish government is having to pay pretty unsustainable rates on its new bonds.)
Why is this a problem? Here are three of the most significant reasons:
- The decline in foreign funding means that Spanish banks are trying to sell a steadily-increasing number of bonds to a steadily-decreasing number of investors. This makes the system much more volatile to sudden disruptions; effectively, just a few employees at each of a few banks are determining the interest rate that the Spanish government has to pay on new bonds.
- If the banks start needing bailouts from the government, and the government has to borrow money to pay for these bailouts, then effectively the banks have been lending to the government so that the government can lend to the banks. If this makes no sense whatsoever, then welcome to the wonders of capitalism. It’s basically the situation that Ireland is already in. Anyway, this would seriously complicate any external rescue.
- If the Spanish government is no longer able to make interest payments on its bonds, then it’s the country’s own banking system that is going to be bearing the entire impact. This would very likely cause many of the banks to face difficulties covering deposits. So not only would citizens suffer from collapse of government services, but also they wouldn’t be able to access their bank accounts.
So yeah, this is a massively unsustainable state of affairs. No way to tell how things are going to go, but it seems increasingly likely that in two years Spain will be basically where Greece is now.
Looks like I’ll be using Pesetas next time I go to Spain.
BCN is going to be cheeeeeeaaaaaaaap.