The Run On Spain

Never believe when politicians tell you how much savings we have now, it will evaporate very fast as soon the confidence is gone



Despite a successful debt auction today, many more economists agree that Spain will now need some kind of bank bailout, definitely from the government and probably from outside organizations like the European Central Bank, other EU countries, and/or the International Monetary Fund.

The chart above from a recent Citi report details why. The percentage of banks' assets provided for by domestic sector deposits has dropped off dramatically in the last year—and particularly in the last few months—while the percentage of bank balance sheets funded by Eurosystem funds has grown exponentially.

This suggests a couple of things. First, deposits are vanishing as the economy contracts and what money would-be investors hold flees the country. This has an important consequence for sovereign debt, too, since domestic banks have been the primary buyers of Spanish debt recently. Unless asset growth from Eurosystem funding can keep pace with deposit flight, banks will no longer be able to keep up these purchases. In this cynical scenario, the value of bonds will decline, yields will rise to unsustainable levels, and Spain could become insolvent.

Second, the Eurosystem is increasingly becoming the vehicle for supporting Spain, making it more likely to embrace a Spanish bank bailout in the future. If the Eurosystem's assets stand to be lost, it will be less likely to allow a series of private defaults to occur.

No matter how much banks try to pump up their capital, the unfortunate reality seems to be that they're going about it in an unsustainable way, particularly if there is no third LTRO.