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The ECB Governing Council met today, and markets were expectant to see what would result. Last week, Mario Draghi promised to take “any measure” to save the euro, and promised that “it would be enough”. So investors were naturally expectant of some combination of:

  1. A promise to buy Spanish and Italian bonds directly on the primary market;
  2. A stated cap on the “tolerable” interest rate on Spanish and Italian debt;
  3. A banking license for the European Stability Mechanism, which would then have been able to borrow unlimited amounts from the ECB to pass on to governments (a fig leaf, at least, for the ECB);
  4. A further cut in the ECB’s key lending rate to supplement last month’s quarter point reduction.

Investors were so confident by the tone of Mr. Draghi’s London speech that Spanish 10-year bonds fell more than 100 basis points during the intervening week. This was despite the storm clouds that quickly began to gather as the surprised Germans began to react.

First, German politicians from Chancellor Merkel’s center right CDU expressed their disapproval and insisted that high interest rates spur reform efforts in Southern Europe.[1] Then, Jens Weidmann, President of the Bundesbank, diplomatically pooh-poohed the notion that the ECB might simply begin to buy bonds on the primary market. With the barest nod at the ECB’s independence, he reminded Mr. Draghi – and everyone else – that the ECB must “respect and not exceed its mandate.” As if the threat were not palpable enough, he then mentioned that the Bundesbank “was the largest and most important central bank in the euro system.”[2]

Translation: “Hey there, hoss: we wear the pants in this here family. Got it, Mario?”

Apparently, Mario got it. So much so that the ECB decided to do nothing during its meeting. No bond buying. No cap on bond rates. No banking license. Not even a cut in the lending rate. He reiterated that governments must continue to push through austerity and pay their debts. If a country needed help, the ECB might help out, but only after the government had asked for rescue funds from the ESM. But Mr. Draghi did reiterate that the “euro was irreversible”.[3]


So blindingly fast was this reverse, that the London Olympic Committee is considering whether to make “back-pedaling” a new sport.



The Spanish business press is understandably fuming.[4] Spain has been thrown to the wolves. The risk premium on 10-year bonds soared immediately after the press conference, pushing yields above 7% again – probably permanently this time. Simultaneously, the IBEX35, Spain’s stock exchange, lost another 5,16% with Spain’s banks as the principal victims: Santander (-6.69%), BBVA (-6.42%), CaixaBank (-6.51%), Popular (-7.91%), Sabadell (-7.53%). Only Bankia – Bankia!!!- posted gains.[5]


I was having lunch with a friend of mine in Madrid on Tuesday, and we were speculating whether the Spanish sovereign rescue would come in October, when the next big bond auction is scheduled, or in August, when everyone is on holiday. Mr. Draghi has almost guaranteed that the rescue will come in the middle of the European vacation period. The 15th of August is a national holiday in Spain – don’t be surprised if that’s when it happens.


Prophetically, the enormous flag of Spain that flies over the Plaza de Colón in Madrid fell to the ground today. Luckily, no one on the street was injured; the slaughter was restricted to the markets.

More than the flags seem to be falling apart in Spain. Even as the government struggles to project confidence to markets, two of its principal regions remain defiant. [6]During a meeting on Wednesday to rein in regional spending, the Catalan representative didn’t bother to show up while the representative of the Andalucian government simply got up and left. Asturias and Canarias stayed, but still voted against Madrid’s plan.

Back in Barcelona, Artur Mas, the Catalan president was furious that his government was forced to seek a bailout package from Madrid because of the lack of a regional tax collection authority – the old canard about Catalonia subsidizing the rest of Spain, to which there is some truth. Tensions remain exceptionally high between Madrid and the prickly Catalans.

Spain is out of time, out of money, and now, out of hope. Mr. Draghi’s discourse has proven as empty as two and a half years of experience with the pronunciamentos of Euro politicos has led us to expect. With the Bundesbank keeping a short leash on bond purchases, with the LTRO having backfired and exacerbated the vicious dependency between bank risk and sovereign risk, and with a banking license for the ECB having been rejected by Germany, there are no more tricks to play. Spain is bankrupt.

Sources and Notes:

 [1] “German Opposition to ECB Bond-Buying Plan Mounts,” Der Spiegel Online, 02 August 2012
[2] Watts, William L., “Bundesbank rains on Draghi’s ambitions,” MarketWatch, 01 August 2012
[3] “Draghi doesn’t back up the talk,” MarketWatch, 02 August 2012
[4] Benito, Maria, “Draghi decepciona: el BCE solo comprará deuda si España recurre al fondo de rescate,” Cotizalia, 02 August 2012 (Spanish only)
[5] Quotes from Cotizalia (www.cotizalia.com)
[6] Serraller, M., “Andalucía se une a Cataluña en el plante al Gobierno y abandona la reunión,” Expansión, 01 August 2012 (Spanish only)

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