Italy and Spain : Risks Are Hidden But Very Real

Rates on the debt of Italy and Spain have reached high levels in 2011 and 2012, even 7% at times, a rate considered as « mortal », because it could snowball into quick defaults. But in 2013 and the start of this year, these rates have been around 4%, in the midst of weak volatility. Does that mean that the crisis in Southern Europe has ended?

Not so fast!... Things appear to be going better, CDs on italian and spanish banks have come down, and stock indices are up. But what about the real economy? Industrial production, investments, household and business credit, construction permits, all taken to the shed in the 2008 crisis, remain lifeless and are not showing any signs of recovery. Unemployment is exploding, so are business bankruptcies, as well as default rates on real estate loans to households. About the latter, also a determinant in the banks’ health : In Spain, loan delinquency is estimated to be around 192 Billion euros, and in Italy, 150 Billion euros. Let’s recall that the european bailout plan for the spanish banks in June, 2012, amounted to 41 Billion euros... a far cry from what is needed. One should hope they’ll be able to generate enough revenue and benefits to cover these charges... In Italy, the oldest bank in the world, and one of the most important ones, Monte dei Paschi, was supposed to raise its capital reserves by 3 Billion euros in December, but has been delaying compliance to this requirement until next June, which puts the institution under pressure.

So where is the good news, what indices are on the way up? Property prices, stock markets, as we’ve said, and of course sovereign bonds (lower rates, from 7% to 4%, mean their prices are going up). This really looks like a bubble! Is there any « real » good news? Spanish businesses profits are on the way up, well above their pre-crisis levels, and the same is true in Italy, albeit at a slower pace. Good news, but a little on the soft side.

A sovereign debt at 4% is not akin to the Eldorado. It is not even sustainable on the long term if GDP growth remains close to zero, which is the case, and if budgetary deficits persist, which is also the case in both countries.
And we know how these low rates happened : with the help of a deluge of liquidities from the ECB with the December,2011, and February, 2012, LTROs (totalling 1 Trillion euros loaned to the european banks on three years at only 1% annual rate) from which the italian and spanish banks have largely profited, namely to acquire sovereign debt which, in turn, helped drive the rates down.

In conclusion, we are facing a bubble. Too few real elements make for optimism. Also, the LTROs will come to terms soon, in December of this year and February of next year. We shall see if the banks will succeed in reimbursing their debts... If not, we might be talking about Italy and Spain in more worrisome terms.