“Your eyes are filled with flowers, but you have your nose and mouth to ignore the pain and tears. You want saints, roses and stars” Pau Riba (Catalan rock star, 1970)

Capital outflows from Spain have reached €247.1 billion. We keep saying it’s due to “fear of the euro break-up”, but we must not forget another added reason. The logical impact of uncertainty on secession. Hence why Catalonia is leading the net destruction of businesses with more than 19,000 companies closing per year.

This week several friends of different investment funds discussed the potential “black swans” of 2013. The three possible black swans in 2013, according to my friends, are: The American fiscal cliff – which we discussed here – the bursting of the debt bubble in Japan – that we analyzed here – and the secession of regions in Spain.

After my article “Catalan bailout and credit risk of junk bond “, I still think that in Spain we minimize the risks of predatory and exclusionary policies and the race to zero that state and regional governments are pursuing.

No single investor I know sees independence as a positive. International banks, as seen in reports by UBS, JP Morgan, RBS, Nomura and others, are warning their clients of the risks and are unanimously negative. This is because:

• Access to capital markets in Catalonia and the rest of Spain would be reduced dramatically. In the debt market, two separate countries do not have the same credit as one united. It never happened. Catalonia would exist, like Cyprus, Malta, Montenegro or Macedonia. Let’s not say it’s impossible. But annual available credit would quickly fall to the levels of those countries, at least 35-40%. Compared with Finland it would mean a drop of 15-20%. The rest of Spain would suffer a similar impact.
• Access to private corporate debt would suffer even more. Catalonia has some of the most indebted Spanish banks and companies in the Ibex with €140bn of outstanding debt. What comes after independence? Taxes, cuts of regulated revenues, bad payments, non-performing loans soar and risk of default. Social Security and pension severed. Private companies would have trouble gaining solid access to the capital markets in the middle of giant refinancing needs (€35bn in three years) until the markets know for sure the impact on cash generation of the new political environment.
• The gap between expenses and revenues is unsustainable. Either way, both separate countries would spend 16% and 25% more than they earn from taxes. With the expected drop in tax revenues from the challenges of a successful transition to independence, the risk premium would shoot much higher. Use any fiscal deficit you want-if you believe them- but even if you accept the separatists’ figure -€16bn- you have to deduct the costs of joining the EU and NATO and all the new state structures, plus the proportion of the bailout cost of its banks and the “pre-received” state bailout. The cost would exceed the –alleged and questionable– benefit.

Politicians on both sides do their analysis on independence as a zero-sum balance or worse, as an expansive result, and that’s wrong. The balance is not zero, it is negative.

No investor sits waiting if the impact of independence on GDP is 5% or 10% or 15%. Investors leave. Goodbye. The benefit of this disaster is neither for Catalonia or Madrid. It is for London or New York, among others, while our politicians talk of “green shoots” and the joys of independence.

The JP Morgan analysis Catalan challenge asks real questions of Europe says that:

If we go to a secessionist environment in Spain it will have very negative effects for both the separated region and the rest of the state -and for the global economy due to the level of foreign-owned public and private debt of Spain and Catalonia in particular. There was not a single case in the past in which independence has not been accompanied by a significant drop in available credit, GDP or welfare. See the study on the independence of the Baltic states of European Journal of Political Economy . An average five years of recession.

In the UK they say “hope for the best, but prepare for the worst”. Yet here separatists are selling the story that independence will generate gold for everyone and it is not true.When discussing Catalonia’s independence always remember: Public and private debt and large combined refinancing needs (€50bn in 2015) make Catalonia a unique problem. The independence of a region or a country can be defended for personal or cultural reasons –which can be discussed elsewhere- but not economic.

This is not to say that Catalonia would not be viable as an independent country. It would be, but in the very long term and after an unaffordable bill. This is what needs to be discussed. What cost we are willing to assume for independence.

At least in Navarre and the Basque Country they used to say “independence will cost us 100 years of poverty, but we will be free.” Honesty. Suicidal, but honest. Separatists promise to increase life expectancy –I swear they do-, increase pensions and that unemployment (750,000 in the region alone) will disappear if Catalonia is independent. And in Madrid we hear that it is terrible for Catalonia, but the rest of Spanish will benefit if separated because Catalan companies will migrate to other regions. Capital is likely to fly away. From both.The day after independence, the following risks ensue:

* The Ireland effect: the problem of Catalonia and Spain is that the public and private debt is unsustainable and crowned by a bloated government structure. Together and apart. Not tackling this problem before entering into a debate about national aspirations is suicidal. What my separatist friends claim that “it will be fixed later, when we are free” is false. The hypertrophy of the new state, the destruction of social security, pensions and services and the rise of corruption always soars after secessionist processes. And the citizens pay.

Catalonia spends 15% more than it earns. If independent, it would see lower revenues and expenses from the transition costs would rise. The Catalonia government, Generalitat, often compares itself to Ireland or Finland. Yet private and public debt together exceeds both. The “crowding out” effect on available credit, absorbed by government in detriment of the private sector and bank bailout costs is very relevant. It would be interesting to see why investors –who are not buying Catalan bonds at all today- would finance a government that spends 15 billion euro a year, 400 million a month in salaries and bills, with more than 150 licensed official cars and a “new country” where public spending is now 33.5 billion annually.

To give you an idea, the first industrial company in Spain, which is seven times the size of the GDP of Catalonia, pays about 700 million euro a month in salaries in Spain, including senior management, and has only seven licensed official cars.

* Credit access equal to Malta, Montenegro, Cyprus, Macedonia, Estonia … Where will Catalonia find 8-9bn of annual credit? Before independence the difficulty of Catalonia to access to the capital markets has been evident as shown by the issuance of “patriotic bonds” to retail investors to pay for current expenses. With mounting “transition costs” and large refinancing needs in 2013-2015 few investors would support a country, Spain or the severed Catalonia, which uses its financial resources to cover current spending and cronyism.

* The Macedonia effect: Macedonia is an independent state that is banned in the EU by Greece. If Spain were to veto Catalonia, it would be an independent country with a currency in freefall. Revenues would plummet, Catalonia and some of its companies and banks –despite large diversification- would have to default on its debt, sweeping away the debt of the rest of Spain as well, as it includes some guarantees to Catalan organizations.* The Estonia effect: Say goodbye to the much trumpeted welfare and social rights. I am surprised reading that independence would improve pensions. All countries that have achieved independence, and among them many are rich in oil and gas, have seen their pension and Social Security systems suffer or collapse. The effect on Spanish government debt would also be devastating, sinking Social Security and pensions, which are up to 80% invested in sovereign debt.

* The Azerbaijan effect : one of my colleagues, who has seen a generation of impoverished countries of the FSU and Baltic regions lets me give you an example of what happens after independence. The political plunder and corruption soar further. “Did you complain of cronyism and corruption? They increase. All for the sake of a GDP decline for five or ten years and then “grow” from a poorer base. ”

* The Scotland risk: David Cameron has said it clearly: “take the share of the UK debt, but not the currency.” UBS in its report “Can Catalonia Leave? Hardly” estimates that the debt of Catalonia would “become 78.4% of GDP after absorbing its share of the Spanish debt”. Even if this were not the case and Catalonia decided to declare its share of state debt as “odious”, the annual deficit would exceed the current 3.7%, because the alleged “fiscal deficit” would be spent on more than covering the new-EU NATO costs, new state structures and the increased cost of debt, which would be around 10% just extrapolating the risk premium of the current Catalan bonds.

* The Wales effect: if Catalonia declared odious its share of debt of the rest of the state, it can say goodbye to transfers, endorsements, business relationships and fiscal deficit balance. When nearly half of the “exports” of Catalonia are to Spain, a very normal reduced trade between the two parties implies a fall in GDP of 10-15% in Catalonia and 2-4% in the rest of Spain, and the debt of the two would skyrocket and solvency would collapse.

Spain after Catalonia independence would find it difficult to have a deficit of less than 8%. Short and Shorter.

The problem of Spain and Catalonia is the waste of scarce resources, ‘political cronyism’. But independence does not solve that. It increases it. Think of “emergency committees” –spending- “assessment of bilateral relations” –more spending- and unions duplicated throughout –more subsidies-.  A country that has today 600,000 more public workers than in 2001, that employs 400,000 politicians in different areas, with 4,000 public enterprises hiding €50bn of debt…

Spain must attack this wasteful mess before deciding what model of state it wants, and the example of England and Scotland can be a good starting point.

I leave you with the words of Marc Vidal: “We are in the hands of people who have not ever set up a company, who have never paid a payroll of their own pocket and that go to work when they want”.

We all want a more efficient management of resources, a taxation system that is closer to the paying citizen. This requires independence, together as a country, but independence from the monster that engulfs everything, the excessive public spending in a bloated political structure, subsidies and cronyism.

My previous post on the subject:
http://energyandmoney.blogspot.co.uk/2012/09/catalonia-bailout-and-junk-bond.html

And my article in The Commentator:
http://www.thecommentator.com/article/2095/an_independent_catalonia_would_be_bad_business

Read more here:
http://www.kioskoymas.com/

“The Spain bailout is the one they do not want to ask for and the one nobody really wants to give”The “Spanish Bailout”…  Wrong term. No rescue for Spain, but the rescue of the Spanish state and its political spending, which is very different.

The biggest risk that investors in bonds perceive is that Spain depends on an ECB support signed by some countries whose citizens do not want more bailouts. Additionally, the market is negatively surprised by the credit ratios of our country, which is already on the verge of reviewing its 2012 deficit target again, to a 7 to 7.2%. And as much as exports improve, they do not offset the effect of four consecutive years with deficits of 7% to 10%, some 350 billion of accumulated deficit since 2008. If we add the future maturing debt, which totals 500 billion in the next four years, the over-supply of Spanish bonds compared with the investor’s ability to absorb more sovereign risk is simply unaffordable .

With the risk premium below 390 basis points and the yield on the benchmark 10-year at 5.75%, we have witnessed the euphoria … of the state. The spending bubble is guaranteed, Draghi supports it. Meanwhile, companies continue to see credit diminishing, and when they receive lending, it is with rates up to 350 basis points higher than the cronyism corporate zombies. And in this process of mummification of the real economy, it is not surprising that non-performing loans of banks reach a 10, 5% and have risen to 178.6 billion euros.

The question is not whether or not there will be a bailout. Unfortunately it is only a matter of time. The question is what will happen the next day.

• Whatever Standard & Poors or Moody’s say, a bailout is the realization of the impossibility of free market finance. Therefore at the time the ECB purchases the first bond, bailout is similar to ” default “. That is known by our politicians and businesses.Using high-level political pressure to avoid junk bond rating before the election is only kicking the can forward. The Moody’s report is very clear. Without bailout Spain would not be ” investment grade ” , ie an independent country that does not satisfy the solvency and liquidity requirements.
• Absolute dependence on ECB: The day after the bailout Spain is an intervened state. Well, even more intervened. Fans of the “Icelandic solution” will be rewarded with their dream, being a country controlled and handcuffed (by the Troika in this case). The Spanish bailout is the one that nobody wants to give and no one wants to ask for. Nobody wants to concede it because ” once you pop there is no stop “. Spain would rely on the ECB to ensure its economic viability, but also would fall under the scrutiny of that entity that would examine monthly the country’s accounts to see how we go. If you think that there have been cuts in Spain so far, you are wrong. They really come the day after the bailout.
• Companies have the greatest difficulty. The “crowding out ” effect of the bailout implies that, again, access to credit is restricted to companies that are left  the few crumbs of credit from European countries that have increased their debt by 3 trillion euros since 2002, and intend to continue. With refinancing needs of European private companies, which create jobs, of a trillion through 2015, it will be a race between predator states, banks deleveraging and companies, in the middle, suffering higher taxes, more interventionism and less credit.

When a country’s solvency, as shown in the graph below, depends entirely on the salvation of the ECB, the risk extends, it is not mitigated. And it’s amazing that, despite the promises of unlimited support, Spain’s solvency is valued at very low levels.

The risks of the next day of the bailout are:

The greater fool theory, and the German plan

Let me tell you what the market calls “greater fool theory.” It is the popular way to try to influence the price of an asset by saying that “someone”-preferably far away and unable to disprove, as “the Chinese” or “the Russians “- is coming, to try to” convince ” investors to buy. Indeed, it sometimes works. Between 2005 and 2009, half of the Ibex was a “greater fool theory ” driven by media rumours of “they tell me for a fact that Chinese will buy it. ” But it works only for a while and then investors learn not to believe the rumors. What happens now with the ECB, which has not bought a single Spanish bond, is similar. And the problem is that they expect it to work.

The German plan, is that, as they do not trust their partners, they want more or less in the middle of 2013 that the outstanding debt held by local investors of problematic countries is at least 85%, preferably 100%. When the debt of Spain and other countries is in domestic hands, the problem and the risk of default and contagion is not European or global, but local and, therefore, countries will have to take good care of breaching their commitments, because the effects of the default fall on the population – internal default-, given that Spain has its social security, pensions and private plans more than 80-90% invested in local public debt.

When they say that Spain would ask for the bailout but not use it, they assume that only the threat of Draghi actions will force international investors to buy Spanish bonds. I don’t see it. If the ECB forces the maximum risk premium relative to the Bund to 200 basis points, as they say, it  will provide the hilarious situation where Italy has to contribute 1.5% of their GDP to the bailout with its own cost of debt at higher levels. Donation?. Then we will have to do the same for Italy and it becomes a pyramid scheme. To infinity and beyond.

Virtual Bailout is a myth
There is no “soft” or “virtual” bailout, limited conditionality, temporary liquidity or any adjective you want to invent.

It is a mortgage and the mortgage cost. And when the country depends on the ECB, once it buys the first bond, the state is mortgaged for life. Unless we curtail public spending that neither Hollande, nor our politicians want to cut. The cuts will come to the big items: pensions and unemployment. No. exports are not going to save us when public debt is 110% of GDP.Private debt … Very publicFor investors, the tales of “debt accounted for deficit purposes” and gimmicks to account less real indebtedness do not matter. Here what counts is all debt and all that is guaranteed by the state. It might be repeated again and again, but it’s a lie, that “private debt is the problem.” Not so. Public debt is our problem. There is no demand and that is why we have to ask for a bailout. And in no small part because a large portion of the debt misnamed as “private” are unpaid bills, guarantees and government IOUs, debt of public companies … none of them counted as “excessive deficit”. But debt nonetheless. Taking into account all financial liabilities issued by the public sector, Spain’s public debt exceeds one trillion euros. And if you add endorsements and guarantees, more … see the chart below.

Illegitimate debt. Ecuador without oil

There are parties in Spain that call for an “audit” of the public debt-default-, deem it as illegitimate -default-and restructure-default-.  Calling “illegitimate debt” to those commitments that have been generated under a democracy and especially between 2008 and 2011 with the approval of each of the parties and unions is surprising to say the least. But above all, they are all living in the land of the unicorns if they think default will impact on future access to credit, on the risk premium and the “social rights of citizens.”

If Spain defaults, we will see the collapse in unison of the Social Security and Pension Funds, invested up to their 90% limit on sovereign debt. And we would see the crisis extend an average of three years, and a drop of 7% of GDP ( Cost of sovereign default, De Paoli, Hoggarth and Saporta ). But above all, when I hear the comments about other countries that have declared illegitimate their debt there is a small point they tend to forget. Almost all countries that have survived these restructurings were oil-rich countries. We want to be Ecuador, but with no oil. And, of course, without its risk premium. And of course, without the credit restrictions of Ecuador. With abundant, cheap credit that we can declare illegitimate again in 2020 and move on. A joke.

Accumulation of debt is not growth

While we see in Spain demonstrations demanding more debt and more spending, and call for policies “of more deficit to grow,” I dare to leave proof that debt is not growth. The graph below, from the study ” A decade of debt (Carmen Reinhart & Kenneth Rogoff, courtesy Peterson Institute) shows that the countries in advanced and emerging economies that have grown the most in GDP per capita have been those that have less debt to GDP (less 30%).I fear that the day after the bailout  the problems will be the same, budget cuts will still be needed and  excessive borrowing will remain. But by then, in a few months, we will not be a problem of global contagion. Our excesses and waste, our debt and its consequences will be our own problem. And investors will continue to prefer buying corporate bonds, that “evil” private debt, before buying government debt of a state on the brink of insolvency. A success.