Spanish Government’s Ponzi Financing Scheme

More signs why the European debt crisis is far from being over.

Spain’s pension fund has been loaded with debt from the Spanish government

From Bloomberg: (bold mine)

Spain’s pension reserve-fund ramped up its holdings of domestic debt last year, profiting from a rally across southern Europe and making it easier for Prime Minister Mariano Rajoy to raid the fund to finance his budget.

The so-called Fondo de Reserva de la Seguridad Social in 2012 increased its domestic sovereign debt holdings to 97 percent of its assets from 90 percent at the end of 2011, according to its annual report due to be presented to lawmakers today at 12:30 p.m. in Madrid and obtained by Bloomberg News.

The fund purchased about 20 billion euros ($26 billion) of Spanish debt last year, while it sold 4.6 billion euros of French, Dutch and German bonds. More than 70 percent of the purchases took place in the second half of the year, after European Central Bank President Mario Draghi pledged to do “whatever it takes” to defend the euro, boosting Spanish bonds.

Two insights from the above.

One, pension funds are subject to government’s predation, thus can’t be relied on.

Two, if the Spanish government defaults on their debt, pension fund beneficiaries will get cleaned out.

Yet more signs of increasing vulnerability of Spain’s welfare state. More from the same article: (bold mine)

Spain’s state-run social security system, also in charge of unemployment benefits, stopped registering surpluses in 2011. Its deficit was 1 percent of GDP last year, contributing to the nation’s total budget gap of 10.2 percent of GDP.

A recession is crimping contributions paid by workers and their employers. At the same time spending has increased due to a record jobless rate of 26 percent and a pensions’ bill, which has risen to 9 billion euros a month from 8 billion euros in 2004.

While the fund stopped receiving government contributions in 2010, its managers changed rules on July 17 to profit from returns from Spanish securities, according to the document.

The maximum amount that can be invested in a given security was increased to 35 percent of the total portfolio from 16 percent. At the same time, the fund raised to 12 percent from 11 percent its maximum share in the Treasury’s total outstanding debt. The Treasury’s debt stock was 634 billion euros in February, according to data on its website.

See why governments have used central bank inflationism to boost asset prices? Gains from asset arbitrages have been used to cover funding shortfalls!

This reminds me of Hyman Minsky’s Ponzi finance from his Financial Instability Hypothesis

Mr. Minsky defines Ponzi finance as (bold mine)

cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts.

In short, Ponzi finance depends on asset values from which is used either as collateral for borrowing or for funding purposes through asset sales.

 

How Ponzi schemes implode, again from Mr Minsky

In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance.

Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.

The difference here is that Mr. Minsky refers to capitalist economies or private finance units as practitioners of Ponzi financing, whereas today it has been governments that rely on Ponzi finance via asset bubbles to sustain their welfare states.

And Spain’s Ponzi finance scheme shows why debt laden governments will unlikely resort to the “exorcise inflation by monetary constraint”, since this will “lead to a collapse of asset values”, thus extrapolates to the collapse of Spain's welfare state.

At the end of the day, what is unsustainable will simply not last, like all ponzi finance schemes, they will fail.