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Spain Bailout Package of $77 Billion Will Not be Enough
- By Diane Alter, Contributing Writer, Money Morning
- June 25, 2012
The Spain bailout package has a steep price, but still might not be enough to save the country's banking sector.
Spanish economy minister Luis de Guindos formally asked Eurozone partners for up to 62 billion euros ($77.4 billion) to recapitalize his country's ailing domestic banks. The financial institutions are weighed down by bad loans to property and construction companies, and by an ongoing Eurozone debt crisis.
In a letter to the Luxembourg Prime Minister Jean Claude Juncker, who serves as head of the 17-nation Eurozone finance ministers, Guindos explained he wanted to settle on details and conditions of the loan before the next euro group meeting on July 9.
Juncker acknowledged receipt of the letter and said that the ministers expect to give a go-ahead to the European Commission, the European Central Bank and the European Banking Authority to negotiate terms of the bailout.
The request was anticipated after the results of two independent audits were released last week. Financial consultants Oliver Wyman and Roland Berger made the first step in a two-part audit of the Spanish banking system.
Wyman found that worst-case scenario, Spain's banking sector would need a bailout package of between 51 billion euros ($63.6 billion) and 62 billion euros ($77.4 billion). Berger estimated on the lower end with 51.8 billion euros ($64.6 billion).
The formal request for a Spain bailout has made investors more nervous, and is driving the bond yields higher, making it increasingly likely Spain will need more money to try and resolve its debt crisis.
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Options 101: Credit Put Spreads Can Boost Your Gains and Lower Your Risk
Last month, Money Morning showed you how to use a technique called selling "cash-secured puts" to generate a steady flow of cash from a stock – even if you no longer own the shares.
It is a highly effective income strategy that can also be used to buy stocks at bargain prices.
But selling cash-secured puts does have a couple of drawbacks:
- First, it's fairly expensive since you have to post a large cash margin deposit to ensure that you'll be able to follow through on the transaction if the shares are "exercised." Thus the name, "cash-secured" puts.
- Second, if the market – or the specific stock on which you sell the puts – falls sharply in price, you could have to buy the shares at a price well above their current value, taking a substantial paper loss.
Fortunately, there is a way to offset both these disadvantages while continuing to generate a steady income stream.
It's called a "credit put spread" and it strictly limits both the initial cost and the potential risk of a major price decline.
I'll show exactly how it works in just a second, but first I have to set the stage…
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Why the U.S. Credit Rating Downgrade Could Cause a Full-Fledged Market Crash
That Standard & Poor's finally downgraded its U.S. credit rating surprised no one – the agency said weeks ago that it would require a deficit-reduction agreement of around $4 trillion to affirm its AAA rating on the United States.
But what the ratings agency doesn't realize is that it's playing with fire. Because what we've seen over the past few weeks has been a massive sell-off in the stock market that suggests Wall Street's biggest players are scrambling to bolster their net capital positions.
And it's entirely possible that this already-stiff correction will snowball into a full-blown market crash.
For months, years even, many of these firms have leveraged their Treasury securities to borrow more money to buy more government bonds and other – more speculative – investments. But since Treasury bills, notes, and bonds can no longer be considered "risk free," institutions are being forced to recalculate their net capital positions to accommodate the added risk.
In industry parlance, this is called a "haircut," and it's exactly what Money Morning Contributing Editor Shah Gilani warned about back in July.
"After studying everything that could happen due to a downgrade of the United States' top-tier AAA credit rating, and the potential default on its debt, we found a scenario that would result in forced asset sales that are so widespread that global stock-and-bond markets would plunge — and economies around the world would crash," said Gilani.
Gilani now says that we could be seeing the beginning of a "global margin call" that will continue to ravish global markets.
The Dow Jones Industrial Average plunged more than 631 points, or 5.52%, yesterday (Monday), after falling 6% last week.
"The sell-off itself got uglier later in the day as margin calls likely triggered more liquidations when there was no bounce after the opening downdraft," Gilani said in an interview. "This is very worrisome. If we don't get a bounce Tuesday morning, but instead see a bad opening, margin calls will ramp up and the effect of rolling collateral and margin calls could turn this correction into a full-fledged crash."
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A Toothless Debt Deal Won’t Stop a U.S. Credit-Rating Downgrade – Or the Aftermath that Follows
It's often said that the sign of a good compromise is that both parties walk away dissatisfied – but that's not necessarily true of the debt deal Congress is close to passing.
To be sure, both parties are dissatisfied with the outcome of this contentious battle. Progressive Democrats are disappointed that planned cuts to government spending won't be augmented with tax increases, while fiscally conservative Republicans are angry that the cuts to spending haven't gone far enough.
But the truth is, regardless of their party allegiances, all Americans should be disappointed in their policymakers for the same exact reason: After months of political kabuki theater, the debt deal that's working its way through Congress is toothless, ineffectual and will do little or nothing to prevent a crushing blow to the markets and the dollar.
The facts of the debt deal are as follows:
- The deal raises the debt ceiling by $900 billion to $17.7 trillion.
- It cuts spending by $917 billion over the next decade and a special congressional committee will be assigned to find another $1.5 trillion in deficit savings by late November.
- If Congress comes up with the savings, or passes a balanced-budget amendment to the constitution, the government will accrue another $1.5 trillion boost the debt ceiling – sufficient to pay the country's bills through 2013.
- If Congress fails, the president will be granted a $1.2 trillion debt-ceiling extension – but automatic, government-wide spending cuts (half of which will come from the defense budget) will take effect in 2013. There will be no automatic tax increases.
The United States at least may have will have avoided default, but the country is still enrapt in debt and likely to incur a credit-rating downgrade.
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Credit Default Swaps:
Why Washington Ignored Our Warning
Three years ago, I told you that Wall Street's newest invention – credit default swaps – would cause a major financial crash.
Now, I'll concede that credit default swaps (CDS) weren't the only cause of the financial meltdown that brought about the collapse of Lehman Brothers Holdings (OTC: LEHMQ) and nearly brought down American International Group Inc. (NYSE: AIG). But these financial derivatives were a major exacerbating factor – which is why I also warned that credit default swaps should be banned.
Just three years later, we're embroiled in yet another financial crisis. But the stakes have grown: This time around we're talking about entire countries – and not just banks – defaulting on their debt. Not surprisingly, credit default swaps are once again at center stage.
Just yesterday (Monday), in fact, the possibility of a Greek-debt default drove spreads on Western European credit default swaps up to record levels, providing even more profits for those speculating against the overall health of the Western financial system. Those profits for speculators increase the overall losses in the world financial system whenever something goes wrong, creating the possibility that even moderate "credit events" could collapse the whole shaky edifice.
If Washington had heeded my warnings back before the first global financial crisis, you and I would be much better off today.
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U.S. Government Faces Credit Rating Downgrade Without Radical Budget Changes
Could the United States lose its status as the world's premier safe harbor for global investors?
Credit-rating heavyweight Standard & Poor's last week threatened to cut the United States' top-tier credit rating, saying the country's political infighting and burgeoning debt may warrant a downgrade.
In short: This country's days as a AAA-rated investment may be numbered.
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British General Election: Even the Winners Will be Losers
The British general election campaign reaches its climax on Thursday, and at this point appears to be anybody's game. The most likely outcome is a "hung parliament" in which no party has a majority and a government is formed through backroom haggling.
However, after looking yet again at the state of the economy in my native Britain, I'm forced to ask a simple question: Why would anybody want the job?
To find out just what the future holds for the British economy, read on…
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Money Morning Mailbag: How the Demise of Glass-Steagall Helped Spawn the Credit Crisis
- By Shah Gilani, Capital Wave Strategist, Money Morning
- February 17, 2010
Question: Please address why the removal of the Glass-Steagall Act in 1999 caused the financial meltdown of 2007 and why its reinstatement is the only way to stop the financially risky behavior allowed after it's removal. Address why we will very likely have another meltdown (probably in 2010) unless reinstated.
Answer: Mr. Scott: While the overturning of what remained of Glass-Steagall did not cause the meltdown, it certainly contributed mightily to the systemic nature of the crisis.
Allowing commercial banks and investment banks to marry created giant operations that became too big to fail and too profitable to break up. Everyone was making money. The overriding problem was not the integration of commercial (deposit-taking and loan-making) banks with investment (capital-markets trading) banks, but the extraordinary migration of all banks into the same products, trading, and risk-taking businesses. I am definitely including the ubiquitous game of mortgage origination, securitization, sales and trading.
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Obama Aims to Spur Small Business Hiring With $30 Billion Lending Program
- By Don Miller, Contributing Writer, Money Morning
- February 2, 2010
In the latest in a series of efforts to spur American businesses to hire more workers, President Barack Obama today (Tuesday) issued a proposal to provide community banks with $30 billion to increase lending to small businesses.
The new lending program aims to invest $30 billion in 8,000 banks to provide loans to businesses ready to hire new workers. Funding for the program would come from money returned by large banks to the government's Troubled Asset Relief Program (TARP), and would require Congressional approval.
"Small businesses…have created roughly 65% of all new jobs over the past decade and a half. And I think we should make it easier for them," Mr. Obama said in a statement obtained by The Wall Street Journal. "This will help small banks do even more of what our economy needs: ensure that small businesses are once again the engine of job growth in America."
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Credit Trouble for Spain and Greece Spreads Fears of Sovereign Defaults
Standard & Poor's today (Wednesday) cut its credit outlook for Spain to "negative" from "stable," fanning concerns that sovereign defaults will spread throughout the global economy.
The dimmer outlook for Spain "reflects the risk of a downgrade within the next two years," S&P said.
It also increased fears among investors that the world could see a wave of global credit defaults. After the default of state-owned Dubai World forced investors to think twice about the recent rally in global stocks, Fitch Ratings Inc. on Tuesday cut Greece's credit rating to BBB+ from A-minus.
