Spanish Yields Down, Finland Wants Cash Collateral

Spanish yields fell at auction, Tuesday, as Spain issued 12-month bills known as Letras. The yields dropped from the previous auction, pricing at 3.918% as compared to the last auction's 5.074%. However, the yields remain elevated compared to May, when bonds were priced at 2.985%.

The fall in short-term borrowing costs for Spain is a positive. High long-term interest rates can be tolerated so long as short-term rates stay low and the issuer can roll over the short-term debt. Spanish 10-year bond yields initially rose but later fell to 6.714%. Spanish two-year bond yields -- a benchmark for short-term borrowing health -- rose 8.6 basis points to 4.583%.

Collateral: Cash Is King
Fueling the rally in Spanish bonds, which comes on earlier weakness, were headlines that Finland and Spain had agreed on collateral for the Spanish bank bailout. In the Greek bailout, Finland had asked for collateral in exchange for bailout money. Now, Finland has reached an agreement with Spain to receive 769.92 million euros in cash as collateral.

Spain was forced to use cash as collateral, as opposed to other assets, as its bonds have a negative pledge clause. This inhibits them from using any assets owned by the state as collateral in any agreements other than official sovereign-debt auctions. Thus, Spain was forced to agree to cash as collateral, which Finland says it will invest in sovereign bonds.

Circular Decisions
The agreement highlights a key theme of the European debt crisis that investors have been fretting about -- European leaders continue to make circular decisions that only lead to further stresses.

Now, Spain would receive bailout money from the European Financial Stability Facility, or EFSF. The EFSF is funded by all member nations on a GDP-weighted basis, so Finland has a 1.8% commitment. Since the Spanish bailout is expected to be approximately 100 billion euros, Finland is responsible for 1.8 billion euros, of which nearly one-third twill come as collateral. Thus, money is just being recycled and circulated, not used for beneficial purposes such as aiding the masses of unemployed people in Spain.