Untangling the Spanish bank rescue

With new complicated mechanisms being announced daily, here’s my take on what the real points of disagreement are:

• Can the Spanish government inject its own bonds directly into a bank that it already owns?

From my point of view, this is biggie. If Spain succeeds in doing this, the crisis is essentially solved. Eurozone countries creating money by borrowing from their own pet bank (which is financed by the governments own bonds) has been a flaw in the design of the Eurosystem from the beginning, and only a gentleman’s agreement has kept it from happening. As you can probably guess, the Germans are going ballistic at this idea, since there isn’t really any limit to the amount of money Spain could create via this route.

This is the reason the increasingly crazy and complicated proposals to have Spain borrow money from the European Stability mechanism. From the German’s perspective, this “sterilizes” the intervention, meaning that no net money has been created, but from the Spanish perspective has very little advantage of just injecting the money directly (other than not pissing of Germany and the ECB).

We’ll see what happens over the weekend.