Do not let anyone tell you fear about Europe's sovereign debt crisis is irrational. It was the market's initial, euphoric rally on the weekend news of Spain's ?100 billion ($126 billion) bank bailout that read from the wrong script, or at least from an overly simplistic one.
The rally became a selloff because of the way the bailout money might flow. Spain failed to negotiate a direct injection into its banks. The dough will move to them through Spain's own bank bailout fund, which means Spanish government debt will rise from 80 per cent of gross domestic product to 90 per cent of GDP.
The new money will also rank for repayment ahead of existing private sector Spanish government bond holders if it is sourced from Europe's new permanent bailout fund, the European Stability Mechanism (ESM). It may rank equally with existing debt if it comes from the temporary European Financial Stability Facility, but the EFSF will be replaced by the ESM soon, probably next month.
Key European nations including Germany favour using the ESM because it gives them better security, and a new tier of preferred debt makes existing Spanish debt potentially less valuable: in the event of a full, Greek-style rescue for example, existing bond holders are less likely to be paid in full.
The ability of even a ?100 billion lifeline to breathe life back into Spain's banking sector meanwhile remains up for debate. At the low end of estimates, Spain says it might only need ?40 billion. Credit Suisse says if property loan losses run to 53 per cent of their nominal value, in the worst case, losses will total ?155 billion: Spanish non-property loan losses would expand the crater to ?249 billion.
Spain's banks are in a by-your-bootstraps position. They took 1 per cent, three-year European Central Bank funding and bought Spanish government bonds in the first quarter of this year, driving yields and Spanish government borrowing costs down.
Fears about their financial health and the ability of Spain to assist them then drove Spanish government bond yields up again, creating losses on the banks' bond holdings, and making the case for their rescue even more pressing. Spain's government hopes they can buy again, and keep a lid on its borrowing costs, but the bank rescue itself makes that less likely, and may not be big enough to save the banks anyway.
Greece's new election looms on Sunday, and Italy's moribund economy and 120 per cent debt to-GDP ratio is on the horizon, and steaming in. Taking money off the table is the right thing to do this week.
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A HOLY GRAIL of infrastructure funding moved a small step closer yesterday when the NSW Treasurer, Mike Baird, confirmed that State Super, the pooled fund for four NSW government defined-benefit schemes, would consider increasing its exposure to infrastructure assets.
State Super has a $31 billion portfolio, with about $2 billion sunk into local and overseas infrastructure. Baird did not announce any new privatisations yesterday, but he did create a swat team inside NSW Treasury to consider the options, and an increase in State Super's allocation to NSW infrastructure assets improves them. It's part of the emerging consensus that governments can finance new infrastructure without blowing up their balance sheets by selling existing infrastructure to super funds.
The infrastructure working group of the federal Infrastructure and Transport Minister, Anthony Albanese, is looking at the same thing, and the Business Council of Australia endorsed it last week, saying private ownership of infrastructure assets was the preferred model where there was a contested market, or a regulated one that gave investors an adequate return.
Super funds prefer existing infrastructure to infrastructure projects there is no development risk, and they can more easily price something that already has a track record.
They are however charged with preserving and growing asset values and superannuation returns, and government asset sales that recreate the sort of losses taken in the private sector on government toll road and tunnel tenders are going to kill the goose. Governments will need to pitch sales at prices that give super funds confidence they are locking in secure long-term investment yields.
The funds have always argued that they do not own a lot of Australian infrastructure because there isn't enough of it to buy, but they will have limits of their own, too.
They diversify risk by holding a basket of assets, including shares, fixed-interest securities and alternative assets including infrastructure. Current infrastructure allocations are between 5 per cent and 15 per cent, and an increase in available assets from government privatisations will not radically change the mix.
Australia's infrastructure funding shortfall can only be totally filled if overseas equity capital is also imported, often in league with an Australian infrastructure investor, as occurred with the Sydney desalination plant privatisation. Selling old infrastructure to pay for new is a good idea, and an overdue one, but it will drive foreign ownership of Australian infrastructure higher as it is implemented.