lunes, 11 de junio de 2012

Bailout: A relief to last?

Many countries in the Eurozone are under financial difficulties and bad debts, not to mention Eurozone banking system is in chaos. States in the periphery are called into question and suffer a painful credit rating. This is the case in Spain, whose banks have been crushed by bad land and property loans. Since 2008 the European Union has deployed all sorts of mechanisms to try to bring safety back to the euro area. But recovery is not happening at all. While interest rates are low, governments have implemented long-term labour market and structural reforms, but the banking system is still full of bad debt, and this is avoiding the real capital to flow to new economic activities.

In this context, some analysts think it's reasonable to wonder what the effect of the bank bailout (100 bn euros) will be. I mean, they honestly ask themselves: Wouldn't it be better to start writing-off bad debt and ensuring that those who have underwritten that lending take losses? Once again it may seem reasonable to ensure that depositors take their share of the pain, just as happened in Iceland.

But let's face the truth. There is no way to make banks fail safely. Even with a proper legal framework, allowing banks to fail won't be the solution, particularly not in Spain, where regional banks have a particular role in financing SMEs. So the recovery of the financial system that is underway would be damaged for a long time. In that sense, the priority now is to allocate capital efficiently to the banking sector so that new capital can flow to real economy.

When the bad loans can gradually be taken off, the balance sheet and the sector can start to function in a normal way. I wonder if the relief we have seen at the stock markets this morning, a positive mood sparked by the Eurogroup bailout, is meant to last. We may see more market pressure on Spain (which is the Eurozone's fourth-biggest economy) and Italy (third economy in the euro area). Both countries are critical to wider Eurozone health and also facing scrutiny of its public finances. Jim Reid, a strategist at Deutsche Bank AG in London says: "The half-life of bailouts have got increasingly shorter over the last couple of years, so it will be interesting to see where the market is in subsequent days and weeks".

Business confidence can't be recovered if large parts of the banks, or governments, are perceived to be on the verge of insolvency. This is one of the main reasons why it makes sense to bailout banks. Not to mention that these kind of compromises ease some concern about the survival of the Eurozone itself.