Europe's Three-Year Medicine Is Already Wearing Off

Spain's in trouble again
An ATM covered in protest stickers reading "Closed by general strike" during a nationwide strike in Madrid, on March 29, 2012. Photograph by Angel Navarrete/Bloomberg

The European Central Bank’s emergency lending program launched last December was supposed to give Europe’s troubled banks and sovereigns three years of relief. But just months later, the medicine is already wearing off.

That’s the problem with trying to fix a solvency problem with liquidity—it doesn’t last. To put it in terms more familiar to a homeowner, it’s like borrowing more money to tide you over when the real problem is you don’t have a job.

Bloomberg News reported today that “a rally triggered by more than $1 trillion of European Central Bank loans to the region’s financial institutions to stave off a credit crunch is running out of steam.”

Spain is the epicenter. The nation’s bearded prime minister, Mariano Rajoy, said the country is in “extreme difficulty.” Demand for the nation’s debt slumped this week, forcing the government to pay 4.3 percent on five-year bonds, nearly a percentage point more than in March. Spain’s IBEX 35-stock index is below 8,000, half its 2007 level. It’s down more than 11 percent in just two weeks.

Mark Grant, an investment adviser who has closely tracked Europe’s snowballing crisis, predicted in December that the emergency lending by the central bank wouldn’t work. Grant, a managing director at Southwest Securities in Fort Lauderdale, Fla., spoke to me about how he sees Europe’s fast-changing crisis. Here are some of his key points:

• “You have solvency issues, severe economic problems in both Italy and Spain. You have very troubled labor markets, social programs that the two countries can’t afford.”

• Because of the Maastricht Treaty, the [European Union] can’t lend money directly to nations. So the ECB lent money to the banks at 1 percent, and lent them all the money they wanted based on collateral. They have three years to pay it back.”

• They’re accepting collateral that’s wholly inappropriate. … A bank could have loaned money to a sandwich shop, and then pledged that loan as collateral.”

• “That game only goes on as long as money is being created.”

• “Spanish banks used the ECB loans to buy the Spanish sovereign debt in each new auction. When there’s no new money, Spain cannot finance Spain.”

• “I am very negative on European credits because there’s no easy, free money left to fund them. A lot of them can’t go to the marketplace [to borrow].”

• “As the liquidity dries up, the solvency issues are going to come back, and they’ll be even worse because of all the new liabilities everybody’s taken on.”

I asked him what Europe should do:

• “First, be honest. Make a clear presentation of the facts and let the world’s investors make an assessment of it and start to deal with it. I talk to a huge amount of big institutions, and these guys have no faith in what Europe is doing. Europe needs the big institutions to help fund its debt.”

• “You should merge or nationalize banks. Not pay the bondholders. Do all the normal things in a corporate default.”

• “Europe’s prescription is like putting a Band-Aid on an artery. We [in the U.S.] are playing the game better than the Europeans.”

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