Wednesday, November 26, 2014

No, Prime Minister, Spain Is Not Uganda

“Aguanta, somos la cuarta potencia de Europa. España no es Uganda.”
---Text message from Spanish prime minister Mariano Rajoy to his finance minister earlier this year.

I’ve been in the credit analysis business since 1978 and I have seen more than my share of “good” credits turn bad. Among them: Continental Illinois, E.F. Hutton, Drexel Burnham, Latin America, Security Pacific, BofA (the first time), the New York money center banks, the Texas and New England banks, the entire S&L industry, Mutual Benefit Life, BCCI, Mexico (again), Credit Lyonnaise, WestLB, Thailand, Korea, Russia, Lehman Bros. (the first time), Argentina (again), Enron, Arthur Anderson, the entire merchant energy industry, the California utilities, WorldCom, Global Crossing, Bear Stearns, Northern Rock, IKB, Allied Irish, HBOS, Lehman Bros. (the second and final time), Merrill Lynch, BofA (again), Citigroup, Greece, Ireland, Portugal, and now.....Spain.

When credit is all you do, your gut sense should become as educated as your intellect. Good credit people should be able to smell bad credits. When Enron began to unravel in the fall of 2001, I read their 2000 Annual Report. As I read, I got a pit in my stomach, almost a panic reaction. Enron’s glossy and entirely invented report was a blinding array of flashing red lights and warning klaxons. I felt in my stomach the utter bottomlessness of their financial situation. Similarly with Thailand and Korea.

What each of these credits (and many of the other catastrophes listed above) had in common was this: a credit whose trajectory was upward. Bad credits (like Uganda) don’t have credit crises, because they don’t depend on market confidence. It is only the “stars” and the “tigers” and the “most admired” companies and countries like Spain that suffer crises because their psychology and their finances were geared for growth, not for reversal. Bad credits are generally ponzi schemes in the sense that they must continuously borrow more to stay afloat.

Recently I have begun I to feel that same fear with respect to Spain, the fear that, like Enron, it is beyond rescue. Like Enron, Spain’s finances are not structured for a credit crisis, only for ponzi-like growth. A cut-off of credit is fatal. I am worried that rescuing Spain is beyond the capability of the mechanisms established to do so. A rough estimate of the price tag for Spain is EUR one trillion, although it could be higher. That is an astronomical sum.

We are not talking about a $30 billion Enron, or a $100 billion Mexico or a $35 billion Greece. Spain is the largest sovereign credit problem since Germany in 1931 . Spain owes the world about a trillion euro in a currency that she doesn’t print.

Unlike the LDCs, she can’t simply impose a payments moratorium and reschedule her bank loans, because her debts are in bonds and deposits, not loans. It is true that many of her official creditors can roll her debt if they choose, and they will have to. But the bulk of her debt remains in unofficial hands, which will not voluntarily roll it as it matures. Spain needs to borrow money from somebody to repay her debt maturities as they come due. That’s hundreds of billions between now and the end of next year. I also don’t know if the ECB will be able to replace all of her banks’ market liabilities with its various loan programs, no matter how low its collateral standards. That’s another huge challenge.

Draghi recently gave a speech in Berlin in which he tried to put a brave face on the situation. Here is the nugget of his remarks:
“My central message to you today is that, provided that all policy-makers persevere with the necessary reforms, we have a number of reasons to be positive about where the euro area is heading. We are seeing signs of improved sentiment in financial markets and we expect the economy to return to growth next year. At the same time, considerable progress is being made on all fronts to strengthen the foundations of the euro area.”

Does that make you feel even slightly better about Spain? When I read this I got that bad credit feeling again. I got the feeling that the captain of the ship wants us to believe that morale-strengthening exercises will restore market confidence, and the ship will sail on.

I have given up on deciding whether Draghi is smarter than all of us, or is himself delusional. In the end it doesn’t matter. Like King Canute, he cannot stop the tide from rising. There is no relationship between what Draghi is saying and what he would ultimately have to do to rescue Spain. So what if he knows the truth? What difference does that make? How is he going to come up with the money he needs as long as the eurozone's price-stability suicide pact remains in place? He has no path to victory, only more of the same disastrous policies with minor tweaks here and there. He says that the OMT is unlimited, which means in practice one trillion euros: can he do that with his current governing council?

This is where my head is at on Spain, that it is a “caso perdido”. Short-term, it can get rescued and the OMT can help. But the restoration of market confidence and market access seems like a chimera. Spain can’t throw her engines into reverse because there is no such lever on her control panel. She needs a new central bank, quickly.

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    1. CommentedJean meil

      Dear former Chairman,
      Enron or the current crisis... what if analysts like Moody´s would have done their job and predict ANYTHING. So sorry, the opinion of analysts is not only as we see useless, but a burden. Please give positive directions and don´t create stupid bubbles than can create pannic in Europe. And please, next time say something before next crisis is coming, cause my grandmother didnt work for Moodys and she predicted it while you big companies were toasting with champagne.

    2. CommentedLuis Cardenas

      Mr. Mahoney, if you were so confident about your "gut feeling" with Enron and the likes why didn't you take advantage of the investment opportunity that it presented at the time. You just throw names around, yet how did Moody's rate those entities/companies before they failed? Respected professionals like you should support bold statements like the one you make in this article with actual data not just "gut feelings"...

    3. CommentedRoberto Mazorriaga Las Hayas

      Which country will be "Uganda"? Which one has been printing money to the tune of billions to buy its own public debt, which nobody else wants to hold? Just as the Reichsbank did in Germany 1920-1923, but in an even bigger scale. Let's wait and see which was the proper policy.

      I beg to disagree.

      Spain does not need a new central bank, it has one the ECB in Frankfurt am Main, issuer of the euro. And the BCE is QUITE CORRECT in not following the stance of the Fed or the Bank of England of issuing BILLIONS of paper money as the US and UK have done ("quantitative easing", "expanding the balance sheet", very funny indeed) to buy its own gilts and bonds and keep them from becoming just "paper" or "monopoly money".

      WOw if would be nice if you would not need taxes and fiscal adjustments anymore, and could live off forever just by printing more paper-money and financing this way your own bigger internal and external debt. Too nice to be true. Just get a central bank that keeps printing new money forever...

      Haven't you heard about hyperinflation Mr Mahoney?

      How did Moody & peers rate Enron, by the way, or Lehmmann, or AIG, or Fannie Mae/Freddie costed millions of taxpayers money and nobody sued your company to bankrupcy as it deserved for its utterly incompetence.

      I am afraid will happen to the USDOLLAR or the Pound.
      You cannot just print billions of paper-money to buy your bonds, as the central banks of US and UK do, instead of doing the hard, real, needed adjustments.

      Spain, by the way and for your information, had a POSTIVE differential agains german government debt only 8 years ago, with a 43% of debt to GDP, the lowest in Europe. True, after 8 years of socialist-cum-catalan goverments it changed to over 80%, which is STILL LOWER than the public debt ratio to GDP of France, Germany, not to speak of Italy.

      The reforms done by the present Spanish government could be faster or deeper but they are surely in the right direction: printing paper-money to sustain for a while your paper-debt is not (visit

      I'm ready to put my money where my mouth ist,

      Let's wait 5-10 years and see if printing money in the BILLIONS is/was the solution to the crisis that Spain had to follow.

      * If you want to talk about real Ponzi Schemes, you should diver your attention to Spain's and all other european States, systems of "social security", wich are being copied by Mr. Obama and the League of Entitlements For All ...What a mistake!

    4. CommentedJorge Sanahuja

      Excellent and at the same time warning information. Because of that is why a huge amount of Catalan citizens want to be independent from the rest of Spain. We are tired of more than 30 years of spoil. Thank you for opening eyes / minds to the world.

    5. CommentedE. Llaudó

      If you see the economic history of Spain, you will find that current situation is not the first time that happens. My oppinion is that Spain itself, their power structures that ever works in same way, are the problem.

      In s.XIX, it was a bankruptcy of Spain very close to current one. Spain treasure had not money at all, but at same time the government made a non-sense politics that prevailed the construction of railways "to anywhere" than an economic inversion criteria.

      Please, Mr. Mahoney, let me to ask one subject. The independence of Catalonia could transform part of the economic problem in part of the solution? Although the lack of official support, the spanish mediterranean regions, as Catalonia, have all of them an strong productive and export capacity, and several economists spanish but also no spanish, say that would overcome by themselves their part of economic troubles.

    6. CommentedCarlos Avendano

      Brilliant article Mr Mahoney. It will definitely spook bond traders and EU finance ministers even more than they were weeks ago. We surely need more of this short-term panic to push the spreads higher. The chimera-like monster was definitely killed this summer; and Mr Draghi knows it.

      Why? Because it is time for our prime minister to accept the Troika rescue package asap and assume his leadership is over. Voters do not trust him anymore. Neither do the markets. Hence, a call for early elections will -hopefully- throw this massive Ponzi-scheme conundrum at the feet of the incumbent candidates.

      And as you well point out, years of over-spending have pushed Spain way deep into the heart of financial darkness. So the new candidate will have to break the creditors' feeble spines before breaking the Leviathan's mighty one. International creditors -as delusional as we Spaniards were during the boom years- must share the loss; and they know it. That is why the credit markets have been closed to Spanish banks for months.

      Nevertheless, I do believe you underestimate two fundamental allies: firstly, the ECB/Germany will do whatever it takes to save Europe. And Spain is fundamental in the big scheme of EU things. And second, who knows if at some point the ECB will accept that financial repression is a hard pill to swallow... but the only one? A 4-5% annual inflation rate and a steady Euro depreciation might be our ultimate weapons against Enron-like crashes.

      Carlos Avendaño / dismal scientist

    7. CommentedManuel Caraballo Callero

      No, Mr. Mahoney, you are wrong in relation to your proposal that Spain needs a central bank itself, and urgently, as you indicated in the last paragraph.
      The reasons will be exposed soon in an article of mine in several Spanish medias and I can sum up in two big problems (among many others):

      1. The current type pta/€ can be around 250, as many financial experts, with huge and sudden impoverishment of families, businesses and government.

      2. The disaster posed to other EU countries if Spain leaves the euro, would destroy the single currency and the EU itself.

      Some Spanish politicians begin to defend that idea. The question behind this nonsense is simply to not be forced to reduce the size of government, eliminate the many privileges of politicians, public companies created on purpose to recruit family and friends of political parties, etc.
      Our politicians forget that Spain at the time of the political transition after Franco's death, we had double digit inflation for years, up from 20% several years running.

      No, Mr. Mahoney, you are wrong.

      Manuel Caraballo