Spanish Yields Fall, Finland and Spain Agree on Bailout Conditions

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 percent as compared to the last auction's 5.074 percent. However, the yields remain elevated compared to May, when the bonds priced at 2.985 percent.

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 short term debt. Spanish 10-year bond yields initially rose but later fell to 6.714 percent. Spanish 2-year bonds yields, a benchmark for short-term borrowing health, rose 8.6 basis points to 4.583 percent.

Fueling the rally in Spanish bonds - following the earlier weakness - were headlines that Finland and Spain had agreed upon 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, not some 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.

The agreement highlights a key theme of the European debt crisis that investors have been fretting about - European leaders continue to make circular decisions which 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 percent 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 they will receive as collateral. Thus, money is just being recycled and circulated and not being used for beneficial purposes such as aiding the masses of unemployed people in Spain.