Moody's Turns Against Spain's Banks

Suppose that most of the estimates of what it will cost to bail out Europe’s weakest nations and their banks are wrong. Suppose that the costs will be twice as much as experts from the International Monetary Fund, European Union and European Central Bank, as well as outside analysts, believe. Moody’s gave the market a glimpse of what might be wrong with predictions about the region in a working paper titled “Spanish Banks’ Upcoming Recapitalization Is Credit Positive, but May Be Insufficient.”

A number of experts were asked to examine Spain’s broken bank system, which has been dragged down in part because of a collapsed real estate market. The experts came back with the conclusion that a bailout of the institutions would cost 53.7 billion euros ($69.2 billion). A check for that amount would make the troubles go away.

But Moody’s claims the price of a bailout could be as high as 105 billion euros ($135 billion). Two members of the Moody’s analyst team wrote:

The recapitalization amounts published by Spain are below what we estimate are needed for Spanish banks to maintain stability in our adverse and highly adverse scenarios. If market participants are skeptical about the stress test, negative sentiment could undercut the government’s efforts to fully restore confidence in the solvency of Spanish banks.

It is too early to tell whether the architects of rescue programs for Spain will balk at a bailout if they believe that Moody’s is right. Since the future of Spain’s sovereign debt is not entirely decoupled from its banks, the rescue of Spain might be larger than anticipated as well. Suddenly, the pool of funds that probably will be earmarked to save the financially weak nations of Europe may not be enough.

The problem of poor estimates did not start with Spain’s banks, nor will it end there. The capital needs of Greece have been reset several times as the nation has fallen further and further into recession. Spain recently said it would not meet its budget goals for 2013. The country will try to remedy that in part by setting austerity plans that will raise taxes and freeze pay among government workers. For some strange reason, it will increase what it pays into pension funds by drawing on 3 billion euros of reserves. Taken together, these are a lot of moving parts. Add to that the fact that Spain’s unemployment rate is 25% and that a recession in the country could be much worse than the government has predicted.

Estimates of government deficits, surpluses, tax receipts and budget cuts are always wrong, usually wrong on the optimistic side. Recessions come along or economies recover more quickly than predicted. The recoveries usually mean more tax revenue. Recessions often cause massive budgets deficits when countries couple stimulus spending with the lower tax receipts that go with the high unemployment and low business activity that economic slowdowns bring.

Moody’s believes that a bailout of Spain’s banks will cost tens of billions more than Spain’s government expects. The cost of aiding the region’s economies likely will be higher than expected in other areas as well. The recession in Europe is worsening. Countries do not want to admit their situations are more dire than expected. Those admissions might cause both capital markets and their rescuers to turn on them.

Douglas A. McIntyre