ECB secretly rescues Spanish banking system

ECB Aid to Spanish Banks
Matches Northern Rock Rescue

By Ambrose Evans-Pritchard
The Telegraph, London
Monday, January 28, 2008

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/01/28/bcnspa...

Spanish banks are issuing mortgage securities and asset-backed bonds on a massive scale to park at the European Central Bank, using them as collateral to raise money at favourable rates from the official credit window in Frankfurt.

The rating agency Moody's said lenders had issued a record E53 billion (L39 billion) in the fourth quarter, yet almost none of the securities have actually been placed on the open market. Most have been sent directly to the ECB for use in "repo" operations.

"The market has shut down," said Sandie Arlene Fernandez, the author of the report.

"Few, if any, of the transactions in the RBMS market [mortgage securities] have been placed since September. Some of the banks are hoping that the market will open up again, but most are just preparing these deals to use as repos, which they can do since the ECB accepts AAA-rated securities," she said.

The total volume of securities issued since the credit crunch began to bite in July has reached E63 billion.

Reliance on the ECB window appears to have kept the mortgage sector afloat despite the sharp slowdown in the Spanish property market and the de-facto closure of the capital markets for this type of business, allowing Spain to avoid the sort of mishap suffered by Northern Rock in Britain and Countrywide in the US.

The data appear to confirm suspicions that the EU authorities have carried out a covert rescue of the Spanish mortgage banking system.

It may equal the taxpayer rescue of Northern Rock in Britain, and possibly exceed it in proportion to the overall size of Spain's economy.

The key difference is that the ECB rescue operation in Spain has been disguised. A veiled method is necessary since the eurozone lacks a clear-cut lender of last resort. The IMF has warned that this gap in the architecture of of the single currency could prove serious in a crisis.

Traders say the Spanish authorities are quietly turning a blind eye to use of the ECB window, and in some cases may be encouraging banks to go to Frankfurt -- a claim denied by the Bank of Spain.

Moody's said the total issuance of securities by Spanish banks last year reached E143 billion, up 55 percent on 2006. More than E62 billion were mortgage securities. The agency said the default rate was likely to rise, with mounting concerns among participants over a possible "housing crash." Some of the mortgage securities have already begun to draw on their reserve funds.

David Owen of Dresdner Kleinwort said Spain could face serious difficulties this year as the excesses of a decade-long boom finally catch up with the country.

"The size of the Spanish corporate sectors financial deficit is truly is really scary. It rose to 14.5 percent of GDP in the third quarter of 2007 from 10 percent in the first quarter. This must be a record for a relatively large economy. Clearly this is not sustainable. Cost imbalances have a nasty habit of unwinding quickly and very painfully," he said.

Mr Owen said Spain was acutely vulnerable since it cannot cut interest rates or let the currency slide to cushion the downturn. "Several years of no growth could now beckon. It will be very difficult for the economy to pick itself up again inside the EMU," he said.

Spanish corporate debt is now 112 percent of GDP. The current account deficit is 10 percent of GDP. These are both flashing red warning signs.

Among those issuing mortgage securities in the last two months are BBVA (E4.9 billion), Caja Madrid (E2.4 billion), Caja Catalunya (E1.6 billion), CAM (E1.4 billion), and Caja Castilla la Mancha (E800 million).

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