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Edward Hugh from Spain Economy Watch says Spanish banks have made €2 trillion of loans from a deposit base of €1.2 trillion, a sobering figure for lenders largely shut out of global capital markets.

The Centre for European Policy Studies (CEPS) thinks Spanish banks will need to write off €270bn, implying “Irish” damage to Spain’s debt trajectory. If CEPS is right, public debt could jump towards 110pc in short-order.

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Spanish banks are parking the ECB money in Spanish bonds for the time being, a costly form of patriotism. The latest spike in yields has devalued their holdings, leaving them nursing a big loss.

There is another insidious effect. As the banks buy the bonds, foreigners sell. External holdings of Spanish debt fell from 50pc to 37pc between December and March. This does at least mean that much of the rising cost of debt payment is recycled within the Spanish economy, limiting the macro-damage. But it also makes it easier for Spain to leave the euro. Investors have noticed this, too. The eurozone is disintegrating.

As for the Spanish economy, it is literally imploding. The budget deficit was 8.9pc of GDP last year, barely down from 9.3pc in 2010. We now learn that the regions have flattered their accounts by failing to pay suppliers €17bn. Valencia is 765 days late on bills, mostly to pharmaceutical companies and healthcare services. The debt of the regions has reached €135bn, or 12.6pc of GDP, chiefly because they look after the elderly and bear the brunt of Spain’s demographic burden.

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...The difficult state of the country's finances was underlined by the latest retail sales figures, also released on Tuesday by the National Statistics Institute.

Spanish retail sales dived in April, showing the biggest fall since the figures started being collected in 2003.

Sales fell 9.8% last month compared with the same month last year, after adjusting for calendar differences.

The fall was much worse than had been expected, and marked the 22nd consecutive month of declining sales. Sales had fallen by 3.8% in March.

Without adjusting for calendar effects, retail sales fell 11.3% in April having dropped 4% in March...

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Spain backtracked on a plan to use government debt instead of cash to bailout Bankia, . . .

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Spain's government Thursday postponed the release of first-quarter budget data from the country's regional governments to Friday.

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“We’re in a situation of total emergency, the worst crisis we have ever lived through” said ex-premier Felipe Gonzalez, the country’s elder statesman.
The warning came as the yields on Spanish 10-year bonds spiked to 6.7pc, pushing the “risk premium” over German Bunds to a post-euro high of 540 basis points. The IBEX index of stocks in Madrid fell 2.6pc, the lowest since the dotcom bust in 2003.

Chaos over the €23.5bn rescue of crippled lender Bankia has led to the abrupt resignation of central bank governor Miguel Ángel Fernández Ordóñez, who testified to the senate that he had been muzzled to avoid enflaming events as confidence in the country drains away.

Markets are on tenterhooks as Spanish yields test levels that forced the European Central Bank to respond last November with its €1 trillion liquidity blitz.“Nobody is short Spanish debt right now because they are expecting ECB intervention,” said Andrew Roberts, credit chief at RBS. “If it doesn’t come -- if we take out 6.8pc -- we’re going to see a hyberbolic sell-off,” he said.

Italy felt the full brunt of contagion from Spain on Wednesday, with 10-year yileds back near 6pc. The euro fell to a 2-year low of $1.239 against the dollar. Crude oil and metal prices plummeted and save-haven flight pushed rates on 2-year German debt to zero. Gilt yields fell to 1.64pc, the lowest in history.

Mr Roberts said the collapse in Spanish tax revenues is replicating the pattern in Greece. Fiscal revenues have fallen 4.8pc over the last year, and VAT returns have slumped 14.6pc. Debt service costs have risen by 18pc.

The country is caught in a classic deflationary vice: a rising debt burden on a shrinking economic base. “Once you get into such a negative feedback loop, you can move beyond the point of no return quickly,” he said.


The European Commission has softened its stance, giving Madrid an extra year until 2014 to cuts its budget deficit from 8.9pc to 3pc of GDP, though this still amounts to a fiscal shock. Brussels told premier Mariano Rajoy to widen the VAT base and speed retirement at 67.

There is no sign so far that the ECB is ready to relent as Frankfurt and Madrid cross swords in an escalting test of will. The ECB has scotched Mr Rajoy’s tentative plans to recapitalize Bankia by drawing on ECB funds.

“It is dangerous to play chicken when you are driving a Seat and the ECB is driving a tank,” said professor Luis Garicano from the London School of Economics (LSE).

Mr Garicano said Madrid has overplayed its hand but the ECB needs to be careful too since Spain is increasingly tempted by the example of Argentina, which recovered quickly after leaving its dollar-peg. “The Rajoy people will do anything to avoid the slow agony of Greece. There is massive disaffection with the euro in Spain and papers like El Pais and Vanguardia are turning anti-German,” he said.

The latest PEW survey shows that just 37pc of Spaniards think the euro has been good for the country. Most still want to stay within EMU but the number is falling fast. The survey found that 40pc of Italians want to return to the lira.
The ECB is pushing Spain to accept a loan package from the EU bail-out fund (EFSF), the proper body for fiscal rescues. Mr Rajoy has refused vehemently. Any recourse to the EFSF is viewed with horror in Madrid, entailing an unacceptable loss of sovereignty.

The result is paralysis as both sides refuse to shift ground. Mr Rajoy is clinging to hope that the EU will take care of Spain’s banks through an EMU-wide recapitalization plan. This would avoid stigma and draconian conditions.
Brussels floated the idea on Wednesday for a eurozone “bank union” and use of the European Stability Mechanism -- which has not yet been ratified by most states -- to rescue banks and sever the dangerous nexus between crippled lenders and crippled states.

The proposals were shot down instantly by Berlin. Such plans amount to debt-mutualization, a form of back-door eurobonds. German opposition is “well known”, said the Kanzleramt.

Sources in Berlin say Germany wants Spain to tap the International Monetary Fund -- as well as the EU -- to spread the rescue burden to the US, China, Japan, Britain and others.

LSE Professor Paul De Grauwe accused the ECB of cherry-picking treaty clauses to justify inaction and failing to carry out its crucial mandate of financial stability. “They should buy Spanish and Italian bonds to cap yields at 300 basis points over Bunds, and let the lawyers argue about it for the next ten years,” he said.

Eurozone data released on Wednesday show that private credit and all key measures of the money supply contracted in April, suggesting that ECB’s €1 trillion liquidity blitz over the winter has failed to gain traction.
Guy Mandy, credit strategist at Nomura, said the ECB has lost sight of the big picture and risks losing the euro altogether if if fails to restore basic confidence. “They need to weigh up events on a grander scale, stop worrying about moral hazard, and do the job of a central bank,” he said.

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Any recourse to the EFSF is viewed with horror in Madrid, entailing an unacceptable loss of sovereignty

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Spain's government has delayed by at least a week the adoption of a new mechanism to ease the funding problems of its heavily indebted regions, a government source said on Friday.

Bajorgensen wrote..

The problem of course is lack of taxation.