Tuesday, 12 June 2012

Selling domestic or foreign assets to solve the debt crisis in Spain

In a recent paper Carmen M. Reinhart and M. Belen Sbrancia categorized major reductions in debt/GDP ratios as being achieved through: (i) economic growth; (ii) a substantive fiscal adjustment/austerity plans; (iii) explicit default or restructuring of private and/or public debt; (iv) a sudden surprise burst in inflation; and (v) a steady dosage of financial repression that is accompanied by an equally steady dosage of inflation to classify the following major global episodes.

The authors then estimate the role of financial repression (i.e. a combination of inflation and negative real interest rates) in solving the post-world war II problems in selected countries shown in the following table:

The implied role played by financial repression is impressive, but its interpretation is questionable in countries like Japan and its acceptance would imply that accumulation of debt in the subsequent period 1980-2010 would be also due to absence of financial repression.

In any case, they missed (or subsumed under adjustment) one of the most important solutions for excessive debt – the sale of assets.

In the context of Spain, the insolvency of the banking system is due to a twin bubble – in real estate and in foreign acquisitions. The first is well known, but few realize the importance of the second and even see it as a source of national pride. To have an idea of the buying spree of big Spanish companies we can illustrate it with the case of Telefonica. In the last decade its CEO Cesar Alierta was a kind of Paris Hilton spending more than $85 billion in acquisitions, an amount close to the $125 billion banking bailout just agreed by the Eurozone members. Botin at Santander and other CEOs did the same.

So the Spanish creditors should demand that she sells a large portion of these foreign investments. This form of tackling desperate financial situations is not without precedents. People do not like to remember this, but the US forced Great Britain to do so to pay for war supplies at the beginning of World War II (Britain had to sell £1.1 billion in foreign assets, ¼ of all its assets).

Again, using Telefonica as an example, we recall that she currently owns €65bn of assets in Latin America which earn yearly €6bn in operating profits. Were they to be sold at book value the net effect on Spains´s balance of payments could pay for more than half of the banking recapitalization needs.

This is not a pleasant solution, but the alternative of burdening future generations with a crippled economy under unbearable unemployment and debts is not better. The Spaniards need to realize that they are not just facing a banking liquidity problem. The fundamental problem is that they need to write-off hundreds of billions of Euros lost in the real estate and foreign investment bubbles and someone must pay for them.

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