The answer to that question is encoded in this article.
Spain is Too Big To Fail Save and Italy is Next In Line
As predicted last December (see "Why the Bazooka will Fail Regardless"), the ECB's LTRO ('bazooka') debt buying programs hastened default by killing the natural market for debt. When LTRO 1 and 2 went into effect, Spanish banks gorged themselves on Spanish government debt to the tune of 300 billion Euros, thereby driving prices higher and temporarily improving their balance sheets. It was supposed to be a three year no-brainer carry trade, but it was a self-propagated illusion.
Three years is the new five months:
As anyone with any knowledge of the markets could have predicted, the boost in debt prices was short-lived and ephemeral, because once the LTRO funds ran out, there was no marginal buyer of Spanish debt. Meanwhile, the Spanish government continues to bring ever more debt to the market to sustain its burgeoning deficits. Also as expected, foreign holders of Spanish debt "hit the bid", and dumped their bonds into the market, taking full advantage of the LTRO-inflated prices, and leaving the Spanish banks as the primary holder of Spanish government debt. Fast forward, and ex-LTRO, debt prices are again spiraling downwards, as each tick lower in bond prices increases yields, translating into higher interest rates (in the primary market) for Spanish government debt.
FULL PONZI - The Reach Around
So...in order to to prop up its banks last week, specifically Bankia, the Spanish government attempted to use its few remaining billions to recapitalize the bank which has been in turn recapitalizing the government these past months. I call this 'the reach around', because it reminds me of a man who shoves his head up his own ass. And no surprise, debt markets were not amused at this stunt, sending bond prices lower and yields higher, today at 6.61%. Apparently, the ECB was not amused either.
END GAME: Spanish Banks Now Dissolving and there is no marginal buyer of Spain's debt
On the asset side of Spain's bank balance sheets, the government debt which is marked to market declines every day, directly eroding bank equity. Meanwhile, depositors are fleeing, thereby drawing down cash reserves. Therefore Spanish banks will soon forced to sell off assets (aka. Government bonds) into an already fragile market to raise cash, further reducing their own equity.
Lastly, as the first article above indicated, there is no European financial stabilization program big enough to restructure Spain's debt load. The new European Stabilization Mechanism (ESM) won't be approved until July at the earliest, and no one knows if that funding would be sufficient. The LTRO programs were strictly for 'Extend and Pretend', and there will be no lasting effect other than to trash the ECB's own balance sheet. Recall that in order to obtain the LTRO loans which were used to buy up Spanish government debt, the Spanish banks pledged 'other loans' as collateral i.e. junk mortgages pledged at 100% face value ! Thereby sticking broader Europe with the sinking value of those collapsing 'assets'.
Now repeat the above and replace the word Spain for Italy.
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Postscript: Anyone reading the above may wonder how I can recommend owning short-term U.S. Treasuries at this juncture. The short answer is that it's a matter of timing, with the U.S. being the last domino in the line. The long answer is in my recent discussion around deflation v.s. inflation.
