Rajoy calls for “break in link between bank debt and sovereign debt”

Just a week has gone by since Mariano Rajoy tried to present the rescue plan for Spain’s banks as a great success, assuring Spaniards that the “credit line,” as he called it, was a victory for the euro and would clear up all doubts about the future of the single currency. But since then, the markets have continued to punish Spain’s sovereign debt, among other reasons because the 100-billion-euro bailout is not going to be pumped directly into the banks, but rather through the government’s Orderly Bank Restructuring Fund (FROB), meaning that Spanish debt levels may rise as high as 90 percent of GDP.

On Tuesday morning, at the Treasury’s first bond auction since news of the bailout broke, Spain’s borrowing costs jumped on 12- and 18-month paper. The government managed to raise the 3.04 billion euros it was aiming for, but at a yield of 5.1 percent. A similar debt sale in May saw a rate of three percent.

In the secondary market, Spain’s benchmark 10-year sovereign bond hit a record high of 7.1 percent on Monday. Rates higher than seven percent are widely seen as being unsustainable.

While Rajoy was denying it last week, Spain has been pressing for direct help for its banks. But Germany and other countries refused, and insisted that the bailout be implemented via the state fund.

However, the Spanish prime minister has done an about turn at the G20 summit. In his speech to the assembled world leaders, according to government sources, Rajoy spoke of the need to “break the link between bank risk and sovereign risk,” which, he said, has “turned out to be incredibly damaging.”

These words are a clear return to the former stance of the Rajoy government – i.e. the need for a direct injection into the banks to avoid the debt being borne by the state.

But European sources on Tuesday said that the Eurogroup is hoping that Spain will formally request the bailout as soon as consultants Roland Berger and Oliver Wyman have completed their analysis of the country’s banking system. The same sources say that there is a “strong preference” among the euro-zone countries to grant the money via the permanent rescue fund (ESM).

The Eurogroup members will be meeting on Thursday in Luxembourg, and European sources say that despite Spain’s wishes, the requirements attached to the rescue will come with “strict conditions” relating to the sale of bank assets, the need to merge or liquidate banks, and the obligation of stepping up the restructuring of banks, in particular the former savings banks, or cajas.

“According to the rules and procedures that are in place, a direct recapitalization program is not possible,” a high-level official said. “I know that there are hundreds of people saying that it is, but it isn’t.”