As was widely expected Friday, Spain this weekend made a formal request for up to $125 billion in aid for its banking sector. Financial markets rallied in reaction, with major Asian markets rising nearly 2% in overnight trading.
"Our conclusion is that liquidity issues will be addressed in the euro zone," David Kotok, chairman of Cumberland Advisors wrote this weekend. "Markets have been pricing in a fear of systemic failure on the liquidity side. Market bears will be disappointed, because the liquidity failure is not going to happen."
But after a big rally in the futures Sunday evening, the enthusiasm was muted Monday morning in the U.S. and Europe amid concern about the details of the bailout and skepticism that any fundamental issues really have been solved. After rallying about 90 points in early trading, the Dow was down about 30 points at 11:15 a.m. EDT.
Spanish officials were able to avoid some of the harsh austerity measures that Ireland, Portugal and Greece were forced to accept as conditions of their respective bailouts.
According to El Mundo, Prime Minister Mariano Rajoy texted his economic minister Luis de Guindos, encouraging him to drive a hard bargain. "Resist, we are the fourth power of the [Eurozone]," Rajoy reportedly wrote. "Spain is not Uganda."
Importantly, the bailout is being structured as direct aid for Spain's banks rather than of the sovereign itself, a distinction critical to Spanish officials. However, questions remain about the source of the funding, which could ultimately be more important than the short-term liquidity boost.
If the bailout comes from the new European Stability Mechanism (ESM), rather than the European Financial Stability Facility (EFSF), the funds would be senior to existing Spanish sovereign debt. That is a key distinction for debt holders, who might be less eager to own Spanish debt if it's not first in line in the capital structure. As a result of such concerns, yields on Spanish debt were rising Monday even as Spain's major stock market jumped nearly 2%.
Update: Citing EU officials, newswires now report the funds will come from the EFSF, meaning it will not be senior to existing Spanish debt. But Bloomberg is quoting German Finance Minister Wolfgang Schaeuble saying the funds should come from the ESM, meaning it would be senior. The devil is in the details, indeed!
However this critical technical issue is ultimately resolved, the Spanish government will ultimately be on the hook for repaying the bailout funds, which will be directed to Spain's government-sponsored bank bailout facility, the Fund for the Orderly Restructuring of the Banking Sector (FORB).
Earlier: Stepping back from the nitty-gritty details, the broader concern is that policymakers keep offering the same medicine but not curing the disease. If Europe truly was a patient, this is probably the point where any competent doctor would try different medicine -- be it Eurobonds or some kind of TARP-style bailout for the banking system.
That being the case, perhaps the best thing that could happen for Europe would be if the relief from the so-called "Spailout" really is short lived, because it might cause EU policymakers to try something different.
"The hour glass though has been turned over but each time it's happened in Europe over the past few years there seems to be less and less sand in it," writes Peter Boockvar of Miller Tabak. "Debt write-down/restructuring is the only true long-term answer if the debt can't be paid back via economic growth."
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