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Friday, March 25, 2011 4:48 AM

S&P Nightmare Scenario: Spanish Housing Prices Drop by 45%, GDP Drops by 20%, Interest Rates Hit 17%; Portugal May Need $99B; Missteps by Merkel

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In the wake of the collapse of the Portuguese government comes the not unexpected news Portugal May Need $99 Billion Rescue

A bailout for Portugal may total as much as 70 billion euros ($99 billion), two European officials with direct knowledge of the matter said, as credit-rating cuts threatened to deepen Portugal’s debt woes.

Preliminary calculations put the cost of a lifeline from 50 billion to 70 billion euros, said the officials, who declined to be named because the issue is confidential. Portugal continued to rule out a rescue after the parliament’s rejection of budget cuts led Prime Minister Jose Socrates to offer to quit.

“It’s pretty inevitable” that Portugal will need a rescue, said Jacques Cailloux, a London-based economist at Royal Bank of Scotland Group Plc. “The market will deteriorate in the absence of other measures going through. There is obviously the risk of further downgrades, which will become anticipated by the markets and be a self-fulfilling prophecy.”
Some Weigh Restructuring Portugal’s Debt

Does Portugal need $99 billion as stated by Bloomberg or $113 Billion as estimated by the New York Times? The real question is when does restructuring the debt of Ireland, Greece, and Portugal start?

Please consider Some Weigh Restructuring Portugal’s Debt
As Europe struggles to come to grips with its debt crisis, which has deepened with the collapse of Portugal’s government after it pushed for yet another round of budget cuts, three numbers stand out: 12.4, 9.8 and 7.8.

Those are the interest rates currently paid on 10-year government bonds for Greece, Ireland and Portugal. That they remain so high — compared with just 3.24 percent on German bonds — shows that investors remain unconvinced that Europe’s haphazard strategy for bailing out troubled, highly indebted countries has succeeded a year after it began.

As heads of state huddled in Brussels on Thursday, with a possible rescue of Portugal on their minds after similar bailouts of Greece and Ireland, the question remained: would Europe accept a resolution it has long resisted — forcing investors to take a loss on their bond holdings to keep the crisis from spreading?

A bailout of Portugal — perhaps to the tune of 80 billion euros ($113 billion) — remains the most likely if not the safest possibility, because it could prove to be another stop-gap measure that might not keep the crisis from spreading.

As the number crunchers from the European Central Bank, tax experts from the International Monetary Fund and other members of the bailout bureaucracy prepare to descend upon Portugal, preaching more budgetary pain and sacrifice, some economists argue that the smarter approach would be to restructure Portugal’s existing debt instead of piling more of it on.
Can Merkel Make Up Her Mind?

German Chancellor Angela Merkel has wasted a lot of political capital by proposing much needed sovereign debt haircuts then changing her mind under pressure from ECB president Jean-Claude Trichet. Moreover, many Germans are upset by her wishy-washy constantly changing bailout proposals that are in violation of the Maastricht Treaty.

In the wake of the nuclear crisis in Japan, she is accused of playing politics regarding her switch on nuclear energy. Now she is balking about an EU proposal she accepted just 4 days ago.

Please consider EU Cuts Future Aid Fund’s Start-Up Capital After Germany Balks.
European Union leaders cut the startup capital for the future euro emergency aid mechanism after German demands to make smaller upfront payments stoked fresh concerns about Europe’s effort to quell the debt crisis.

As speculation swirled that Portugal will be the next victim of the crisis, the leaders bowed to German Chancellor Angela Merkel’s call to pare the fund’s paid-in capital as of 2013 to 16 billion euros ($23 billion), less than the 40 billion euros foreseen in a March 21 accord.

“It was a difficult debate with Germany,” Luxembourg Prime Minister Jean-Claude Juncker told reporters after the first session of an EU summit in Brussels early today. “Germany found that in the compromise agreed last Monday it would have to pay in too much. So we had to tackle that issue.”

With Merkel’s party trailing an opposition bloc in the polls before a March 27 regional election, the sparring over the future emergency support system reflected domestic political pressure on leaders in Europe’s wealthier north to limit aid to struggling southern economies.

Merkel’s renegotiation of the three-day-old financing accord punctured the EU’s proclamation of a “comprehensive” anti-crisis strategy, including tougher sanctions on excessive budget deficits and national pledges to increase competitiveness.

German political jitters over propping up debt-swamped states dominated the crisis response last year, with Merkel delaying aid for Greece and calling for bondholder losses that hastened Ireland’s plunge into the fiscal abyss.
Spotlight on Spain

The Wall Street Journal reports Spain Takes Turn in Debt Spotlight
Portugal's admission that it will probably need a financial bailout raises a question that will shape the outcome of the euro zone's debt crisis: Is Spain next?

The cost of saving Spain, a €1.1 trillion ($1.56 trillion) economy, would dwarf previous bailouts and could test the financial strength of Europe as a whole.

But if Spain can continue to repair investors' trust, as in recent weeks, then Europe stands a chance of containing the debt crisis to three countries, Greece, Ireland and Portugal, whose combined economies are half the size of Spain's.

Spanish bonds and stocks, including those of banks, rose Thursday despite the downgrades and concerns that Spanish lenders could be hit by the deepening crisis in neighboring Portugal.

Spain's borrowing costs have stabilized and come down slightly in recent months, whereas investors have continued to dump bonds of the three smaller crisis-hit countries.
Spain's budget deficit, at 9.2% of GDP last year, remains too high for comfort, but was down from more than 11% in 2009. Spain improved its credibility with investors by meeting its deficit-reduction target, despite overspending by some regional authorities. This year's deficit target of 6% is achievable, said economists, but might require extra fiscal measures if economic growth disappoints.

The economy grew at an annualized rate of 0.9% in last year's fourth quarter, marking another contrast with Greece, Ireland and Portugal, which stayed mired in recession. Spanish consumer spending is falling thanks to mass unemployment and households' efforts to reduce their debts, but Spanish exports are doing better than expected, growing at an annualized 16.6% last quarter.
Spain's Capital Shortfall "Substantially" Higher than Bank of Spain Admits

Spanish lenders face a capital shortfall that’s “substantially” higher than an estimate by the Bank of Spain because they haven’t accounted for all of their real-estate losses says Jesus Ecinar, founder of the largest property website in Spain.

Please consider Bank of Spain Underestimates Funding Gap Faced by Lenders
Spanish lenders face a capital shortfall that’s “substantially” higher than an estimate by the Bank of Spain because they haven’t accounted for all of their real-estate losses, according to Jesus Encinar, founder and chief executive officer of Idealista.com.

As much as 15.2 billion euros ($21 billion) is needed by Spanish banks to meet new capital requirements, the central bank said on March 10. Encinar, 40, said the eventual shortfall may be between 80 billion euros and 100 billion euros. A spokesman for the Bank of Spain declined to comment on his estimate.

“Property portfolios are still mostly valued at prices dating from the boom, rather than current values,” Encinar said during an interview at his office in Madrid. Home prices in some parts of Spain have dropped about 40 percent since the market’s peak in 2007, according to his 10-year-old company, the country’s largest property website.

Savings banks alone have taken on land worth 23 billion euros after borrowers defaulted on their loans, according to data from the Bank of Spain. Land prices have fallen as much as 80 percent in the past four years and the valuations used by lenders are “pure fantasy,” Encinar said.

On March 15, Spanish Finance Minister Elena Salgado said that estimates of lenders’ capital needs by rating companies aren’t comparable with those of the Bank of Spain and the firms should explain their methodology.

While the Bank of Spain does a “simple subtraction” to see how much capital is needed to meet the new rules, the rating companies make “presumptions on the amounts our lenders would need to cope with certain eventualities.”

Inflated Prices

Banks and other financial-services companies advertise homes at prices that are as much as 12 percent higher than privately owned properties, according to Idealista. In return, they offer better mortgage terms, Encinar said. In some cases, banks only grant mortgages for homes that they own.

“We tried to inform the banks about the market value of their properties, but they won’t reduce prices because it would affect the data that the banks are giving to the Bank of Spain,” he said.
Spain's Nightmare Scenario

Nearly every day of the week I receive emails from my friend Bran who lives in Spain.

Many of the links Bran sends are in Spanish. Sometimes he translates the highlights. Today he writes ...
An S&P "nightmare" scenario quoted by El Pais, not only assumes a fall in housing prices by 45%, it also assumes GDP to fall by 20% between 2011 and 2015, a destruction of a quarter of today's jobs and interest rates to reach 17%. In this worst case scenario Spanish banks and savings banks would need an injection of public capital of €64bn, equivalent to 6% of GDP.
Spanish speaking readers may wish to consider "La agencia parte de una caída del PIB del 20% y una destrucción del 25% del empleo"

English Speaking readers can follow this Google translation: S&P believes that in an extreme case the bank would need 64,000 million

Right now, the two things propping up the Euro are Trichet's expected rate hikes and speculation that Spain will not need a bailout. Both are questionable ideas to say the least.

I happen to think the "nightmare" scenario is the realistic one. If so, those who think Spain will not need a bailout need to think again.

Mike "Mish" Shedlock
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