Iberian Bailout

• Portuguese bond auction yields hit fresh highs, spiking well over yields from a similar auction just one month ago.
• The creation of the European Financial Stability Facility adds some calm to markets as it has ample liquidity through 2013.
• However, the long-term survivability of the eurozone rests on the ability of EU leaders to resolve issues with the creation of a permanent bailout facility.

This week, Portuguese bond yields hit fresh highs. Major ratings agencies continued to cut the country’s debt rating (mostly confirming what yields have already been telling us), and banks began refusing to purchase more government bonds. This led soon-to-be-former Prime Minister Jóse Sócrates to formally request financial aid from the European Commission—a move already widely expected. Portugal is now the third eurozone country, after Greece and Ireland, to be bailed out. And markets mostly yawned.

Which is a good illustration of how far markets have come since PIIGS became a household acronym. Recall, in February 2010, Greece admitted to a bit of book cookery. As the depth of Greece’s financial woes became better known, investors feared a debt contagion would spread to fiscally weaker eurozone members (the PII and the S), and beyond—and stocks went on a roller coaster ride. That morphed to fears over the long-term viability of the eurozone, kicking off a sizeable global market correction. This lead to the creation of a temporary and massive bailout tool—the European Financial Stability Facility (EFSF)—to prevent the collapse of eurozone members and stymie potential debt contagion. Greece received approximately €110 billion at rates better than they could receive on the open market and agreed to stiff austerity measures. Ireland was bailed out next, receiving approximately €67.5 billion under similar terms.

And now, Portugal. No doubt, the global yawn on this news is tied to it being widely expected. Final terms and details still must be hammered out over the course of the next few weeks, but it likely is in the range of €70-€80 billion(with a €10 billion bridge loan until parliamentary elections in June) and looks similar to the Greek/Irish deals. No one doubted Portugal would need a bailout—the request was likely put off until this week by politics. The required austerity cuts were politically unpopular, and the rising Social Democrats (whose rejection of the proposed austerity measures led to Socrates’ resignation) wanted to have their cake and eat it too. They’ll get their bailout, they won’t wear the blame for the austerity cuts, and now, with the bailout imminent, some uncertainty about Portugal’s financial situation is removed.

Though Portugal is saved until another day, the long-term survivability of the eurozone will continue to be a plausible market risk—rightfully so. The EFSF is just a band-aid. A permanent tool, the European Stability Mechanism (ESM), will provide available emergency funding on an ongoing basis. However, eurozone leaders have yet to come to full agreement over many of the details. Still, PIIGS shouldn’t be bear market-making material in 2011 as the EFSF still has ample liquidity and is in effect until 2013.