FT Alphaville " Spain's long climb to the liquidity hospital [updated] UPDATE: We have a denial or two. This is from the ECB's twitter account: And the Spanish Economy Minister made the same denial in parliament saying that the ECB didn't reject any plan on Bankia. This is all getting rather murky. Oh, look! It's another euro-era record spread for Spanish 10 years over their German counterparts after the ECB said "no thanks" to Spain's plan for a sneaky bit of backdoor ECB financing. The ECB told Madrid that a proper capital injection was needed for Bankia and its plans were in danger of breaching an EU ban on "monetary financing," or central bank funding of governments, according to two European officials... Senior government officials in Madrid argue that bailouts in Portugal, Greece and Ireland have been catastrophic and Spain will not compromise on its refusal to accept a similar form of intervention... Based on this chart it's more Russian Roulette than poker at this stage: That's Spanish 10-years at near 6.7 per cent while German bunds are at a low of 1.34 per cent. Add that to a record 580bps for Spanish CDS and it's easy to see why JP Morgan's David Mackie believes Spain is "climbing the steps of the liquidity hospital": The ECB's rejection of the Spanish government's plan to recapitalise Bankia - by injecting government bonds directly into the bank which would then be used as collateral in ECB financing operations - puts Spain on the steps of the region's fiscally based liquidity hospital (EFSF/ESM). It looks increasingly likely that it will be knocking on the door soon asking to be admitted. The Spanish government recognises the need for burden sharing, but it does not want the kind of burden sharing that was made available to Greece, Ireland and Portugal. The Spanish government wants the ECB to directly purchase its sovereign debt and for the EFSF/ESM to directly recapitalise its banks. As far as a genuine shift in credit risk is concerned, there is no real difference between ECB sovereign bond purchases and EFSF/ESM loans to the sovereign. From the Spanish government's point of view the former is more attractive because there is no loss of sovereignty: SMP bond purchases do not come with conditionality. But, who recapitalises the banks is a huge issue. Given the likelihood that there are still a lot of losses that have not yet been recognised, a capital injection into the Spanish banks directly from the EFSF/ESM would be a boon for Spanish taxpayers. Future losses would be absorbed by the area wide taxpayer. But, the sort of burden sharing that the Spanish government wants is not on offer... Before Spain asks for admission into the liquidity hospital we may see the SMP reactivated. But, given that the Spanish situation looks increasingly like a solvency crisis - the government is not solvent enough to recapitalise insolvent banks - the ECB is unlikely to view the SMP as an appropriate long term response to this problem. More likely, SMP purchases would simply be used to limit market turbulence while a traditional bailout package was negotiated. This entry was posted by David Keohane on Wednesday, May 30th, 2012 at 9:34 and is filed under Capital markets. Tagged with eurozone, spanish bonds.