I ran across two articles today that are each individually quite concerning to those who understand the precarious nature of the global economic recovery. However, in putting the facts of these two article together, the big picture just got a lot scarier.
An article entitled "'Bastante mal' for Spain's banking shares"in MarketWatch today exposes the deteriorating situation of the major Spanish Banks. These banks have seen a steady, and significant decline in 2010 due to doubts over the country's ability to reign in government spending (sound familiar?), coupled with a nearly 20% unemployment rate (again, sound familiar?). Most people have not noticed the problem in Spain because Greece is getting the headlines, but Spain is not far behind, and their economy is substantially larger than Greece. Both Barclay's, and Moody's issued downgrades to the major Spanish banks, and their associated securities (approximately $32 Billion) stating that in comparison to other major European banks they "are likely to be eroded "significantly" owing to increasing signs of stress in Spain's domestic property exposures and fears over the fiscal situation there."
The article goes on to tell how Markets & Investors are "fretting" over reports that the Bank of Spain is going to raise Minimum assets held as provision against repossessed real estate (Familiar?) to 30% from 20% which was only 10% as recently as November. This was confirmed by Spain's Central Bank Governor.
While this is not good news, it is not Earth shattering, or Global Economy rattling. That is until you see what Karl Denningerposted today concerning the latest fallout from AIG, and I'm not talking about today's reported 4th qtr. loss of another $8.9 Billion. Denninger found a bombshell in the company's 10Q reports (In the 10-Q, firms are required to disclose relevant information regarding their financial position quarterly) that they have an exposure of an additional $150 Billion in Credit Default Swaps (CDS) which are mainly derivatives for European Financial Institutions like the Spanish Banks.
I know CDS are complex, and most people just understand them as an insurance against bad bets, but bear with me. Here's the devil in the details of the report concerning the nature of these CDS "AIG understands to have been originally written primarily for the purpose of providing regulatory capital relief rather than for arbitrage purposes." So what exactly does that mean? Denninger explains it best "So AIG "understands" that $150 billion of credit-default swaps were written by AIGFP to European Institutions (no note by the way as to exactly what's in there - or who owns them) for the explicit purpose of getting around capital requirements - either by banking regulators or (possibly worse) EU sovereign regulations.
What this means is there is a distinct possibility that AIG knew these were being written as a "magic" way to create Capital where it specifically did not exist. The 10Q shows that the net fair value for these CDS is only $116 Million, meaning they are pennies on the dollar compared to liability. Now put that information together with what is the verge of a default by the country of Greece, and then extrapolate it to the much larger country of Spain. Since Spain is possibly going to require further capitalization on the part of their banks, and this could be the smoking gun that the last increase was nothing more than a Bernie Madoff illusion, where does that leave us?
Remember those bonds I mentioned being downgraded by Moody's and Barclay's? Well, expect foreign investors to want to sell them before they take too big a loss, which in turn will put more pressure on interest rates. This typically leads to a spiral effect of deteriorating currency that can make it impossible for the country to repay its debt when those bonds are denominated in a foreign currency (US Dollars?). With Greece this does not apply as most of their bond problems are denominated in Euros. However, Greece then has the problem of not being able to hyper-inflate/print their way out of the problem.
So what happens when Spanish banks are unable to raise the necessary capital to meet the new requirements? They will cash in those CDS that AIG never thought they would have to pay out is the best bet. However, no one knows for sure because AIG has confidentiality clauses pertaining to these CDS, but I'm betting the American taxpayer will then be on the hook for bailing out Spain.
How does it feel to be in a position to have bailed out the US banks on the order of Trillion$ over the last year, and now we're looking at the same for Spain?