Spain is following Greece in its path to bankruptcy

The situation in Spain is looking worse every day. I believe Spain is following the path of Greece into bankruptcy.

Let’s take a look at the Spanish bond yields. At the end of 2011 we got the massive ECB bailout package named Long Term Refinancing Operation (LTRO). This relieved the bonds of certain peripheral governments like Italy, Greece and Spain. Lately though, with many Spanish regions on the verge of bankruptcy, Spanish bond yields are rising again. Let’s take a quick look at these.

The best way to look at stress in the bond yields is to look at the bond spread between long term maturities (Chart 1) versus short term maturities (Chart 2). If the spread narrows, it means there is stress, because the shorter maturity is about to rise above the longer maturity bond yield. Normally in a healthy economy, longer maturities always have higher yields than shorter maturities. If this is not the case, this means that defaults are looming (see Greece bond yields: shorter maturities have higher yields than longer maturities).

To read the analysis go HERE.

Chart 1: Spanish 10 year bonds

Chart 2: Spanish 2 year bonds

A Look at the Balance Sheets of the U.S. Banks

During the financial collapse of 2008, the problem of the banks was their balance sheet. Banks were highly leveraged compared to their equity. On average, the assets held by the banks was 10 times their equity. This means that a 10% decrease in asset value at constant liability levels could bankrupt the whole company.

The first problem was debt (liabilities on the balance sheets) and the solution was deleveraging. Banks needed to reduce the size of their assets and reduce the size of their liabilities. The second problem was liquidity and the solution was increasing reserve ratios. This article will summarize and analyze what happened during these 3 years after the financial collapse in 2008.