Madrid Threatens Intervention as Regional Debt Worries Mount

The Financial Times reports Madrid threatens to intervene in regions

Madrid has threatened to seize budgetary control of wayward Spanish regions as early as May if they flout deficit limits, officials said – as investors took fright at the fragility of some eurozone economies.

Concerns about overspending by Spain’s 17 autonomous regions and fears that its banks will need to be recapitalised with emergency European Union funds undermined confidence in the country’s sovereign bonds, forcing down prices and pushing yields up above 6 per cent on Monday – towards levels considered unsustainable.

The cost of insuring the country’s debt also rose, with Spanish credit default swaps jumping to a record 510 basis points, according to Markit, the data provider.

One possible candidate for intervention is Andalucia in the south, Spain’s most populous region, which has attacked Mr Rajoy’s austerity measures. Mr Rajoy’s Popular party had hoped to win a regional election last month and oust the leftwingers who have run Andalucia for 30 years but the PP did not get enough votes and the left remains in control.

Andalucia, however, is not alone in failing to obey fiscal rules. All the major political parties, including the PP, have exceeded deficit targets in the regions they administer.

Spain Government May Take Over Some Regions’ Finances

The Wall Street Journal has additional details in its report Spain Government May Take Over Some Regions’ Finances

Spain’s government Monday warned it could take control of finances in some of its autonomous regions to slash one of Europe’s largest budget deficits and shore up investor confidence.

A top government official, who asked not to be named, told journalists there will soon be new tools to control regional spending. Parliament is expected to pass legislation by the end of this month allowing Madrid to force spending cuts, impose fines and take over financial management in regions breaching budget targets or falling into deep difficulties.

The official said Madrid may move take over at least one of the country’s cash-strapped regions this year, as lack of access to financial markets and plummeting tax revenue are undermining their capacity to fund themselves.

“The way things are going, the regions themselves will request the intervention,” the official said. “There are regions with no access to funding, no way to pay bills. That’s why we are going to have to intervene.”

The official added Madrid should have more information by May on the state of regional finances, and on which might need to be taken over. The government has set up a new credit line to regions so they can pay off large debts to their suppliers. To access the facility they must present a plan to pay back the money and provide detailed information on their finances.

Separately, Spanish Education Minister Jose Ignacio Wert met regional education authorities to agree a series of measures, including larger class sizes and longer teachers’ hours, to cut EUR3 billion from regional budgets. The government meets regional health officials Wednesday to find another EUR7 billion in cuts. These two social services account for the bulk of regional spending, and the regions have long complained they can’t reduce it unless Madrid changes regulations governing the services they must provide.

Mission Impossible

Wolfgang Münchau a Financial Times columnist says Spain has accepted mission impossible

News coverage seems to suggest that the markets are panicking about the deficits themselves. I think this is wrong. The investors I know are worried that austerity may destroy the Spanish economy, and that it will drive Spain either out of the euro or into the arms of the European Stability Mechanism.

The orthodox view, held in Berlin, Brussels and in most national capitals (including, unfortunately, Madrid), is that you can never have too much austerity. Credibility is what matters. When you miss the target, you must overcompensate to hit it next time. The target is the goal – the only goal.

This view does not square with the experience of the eurozone crisis, notably in Greece. It does not square with what we know from economic theory, or from economic history. And it does not square with the simple though unscientific observation that the periodic episodes of market panic about Spain have always tended to follow an austerity announcement.

European policy makers have a tendency to treat fiscal policy as a simple accounting exercise, omitting any dynamic effects. The Spanish economist Luis Garicano made a calculation, as reported in El País, in which the reduction in the deficit from 8.5 per cent of GDP to 5.3 per cent would require not a €32bn deficit reduction programme (which is what a correction of 3.2 per cent would nominally imply for a country with a GDP of roughly €1tn), but one of between €53bn and €64bn. So to achieve a fiscal correction of 3.2 per cent, you must plan for one almost twice as large.

Spain’s effort at deficit reduction is not just bad economics, it is physically impossible, so something else will have to give. Either Spain will miss the target, or the Spanish government will have to fire so many nurses and teachers that the result will be a political insurrection.

Market Screams Mission Impossible As Well

I too have been preaching the “Mission Impossible” idea for months if not years. More importantly, the market has once again latched on to that idea with credit default swaps on Spain’s sovereign debt at record highs, and the yield on 10-year Spanish bonds back above 6% today, settling at 6.07% after reaching a high of 6.156% according to Bloomberg.

History suggests the more eurocrats resists a default for Spain, the bigger the resultant mess. Greece should be proof enough. However, eurocrat clowns have no common sense, no economic sense either, and they do not care about history. Expect a gigantic eurozone mess as efforts to kick the can do nothing but make matters worse.

Mike “Mish” Shedlock
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