Spain Bailout Would Cost More Than What’s Available In Existing Emergency Funds
By David McHugh, Huffington Post – July 23, 2012
FRANKFURT, Germany — Europe is on the brink again. The region’s debt crisis flared on Monday as fears intensified that Spain would be next in line for a government bailout.
A recession is deepening in Spain, the fourth-largest economy that uses the euro currency, and a growing number of its regional governments are seeking financial lifelines to make ends meet. The interest rate on Spanish government bonds soared in a sign of waning market confidence in the country’s ability to pay off its debts.
The prospect of bailing out Spain is worrisome for Europe because the potential cost far exceeds what’s available in existing emergency funds. Financial markets are also growing uneasy about Italy, another major European economy with large debts and a feeble economy.
Stocks fell sharply across Europe and around the world. Germany’s DAX plunged 3.18 percent. Britain’s FTSE dropped 2 percent and France’s CAC 40 fell 2.89 percent. In midday trading on Wall Street, the Dow Jones industrial average was down 1.35 percent. The euro slipped just below $1.21 against the dollar, its lowest reading since June 2010.
The interest rate on its 10-year bond hit 7.56 percent in the morning, its highest level since Spain joined the euro in 1999.
Concern over Spain increased Monday after the country’s central bank said the economy shrank by 0.4 percent during the second quarter, compared with the previous three months. The government predicts the economy won’t return to growth until 2014 as new austerity measures hurt consumers and businesses.
On top of that, Spain is facing new costs as a growing number of regional governments ask federal authorities for assistance. The eastern region of Valencia revealed Friday it would need a bailout from the central Madrid government. Over the weekend, the southern region of Murcia said it may also need help.
Spain has already required an emergency loan package of up to (EURO)100 billion ($121 billion) to bail out its banks. But that aid hasn’t quelled markets because the government is ultimately liable to repay the money. It had been hoped that responsibility for repayments would shift from the government to the banks. But that shift is a long way off – a pan-European banking authority would have to be created first and that could be years away.
Yet it is far more than Spain’s struggle that has unnerved markets.
Greece is still struggling with a mountain of debt and international creditors will visit the country Tuesday to check on the country’s attempts reform its economy. There is concern that officials from the European Commission, European Central Bank and the International Monetary Fund will find that that Greece is not living up to the terms of its bailouts and could withhold future funds.
Italy has also been caught up in fears that it may be pushed into asking for aid. Italy’s economy is stagnating and markets are worried that it may soon not be able to maintain its debt burden of (EURO)1.9 trillion ($2.32 trillion) – the biggest in the eurozone after Greece. Interest rates on Italy’s government bonds rose steeply Monday while its stock market dropped 2.76 percent.
The collapse in stock prices in Italy and Spain prompted regulators to introduce temporary bans on short-selling – a practice where traders sell stocks they don’t already own in the hope they can make a profit if the stock falls in price.
Pascal Lamy, director of the World Trade Organization, said after a meeting with French President Francois Holland that the situation in Europe is “difficult, very difficult, very difficult, very difficult.”
Ireland, Greece and Portugal have already taken bailout loans after they could no longer afford to borrow on bond markets. Yet those countries are tiny compared to Italy and Spain, the third- and fourth-largest economies in the eurozone. Analysts say a full bailout for both could strain the other eurozone countries’ financial resources.
Spain has already received a commitment of up to (EURO)100 billion from other eurozone countries to bail out its banks, which suffered heavy losses from bad real estate loans. Eurozone finance ministers signed off on the aid Friday and said (EURO)30 billion would be made available right away. But that incremental step cuts little ice with investors. If Spain’s borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue.
“Events since Friday have been a clear wake-up call to anyone who thought that the Spanish bank rescue package had bought a calm summer for the euro crisis,” analyst Carsten Brzeski said.
The eurozone’s bailout fund, the European Stability Mechanism, has only (EURO)500 billion in lending power, with (EURO)100 billion potentially committed to Greece. Italy and Spain together have debt burdens of around (EURO)2.5 trillion. And the ESM hasn’t yet been ratified by member states plus eurozone governments have made it clear they won’t put more money into the pot.
That once again pushes the European Central Bank into the frontline against the crisis.
On Saturday, Spain’s Foreign Minister José Manuel García Margallo pleaded for help, saying that only the European Central Bank could halt the panic. But the ECB has shown little willingness to restart its program to purchase the government bonds of financially troubled countries. The central bank has already bought more than (EURO)200 billion in bonds since May 2010, with little lasting impact on the crisis.
The central bank has also cut its benchmark interest rates to a record low of 0.75 percent in the hope of kick-starting lending. Yet many economists question how much stimulus this provides as the rates are already very low – and no one wants to borrow anyway.
There has been speculation the ECB could eventually have to follow the Bank of England and the U.S. Federal Reserve and embark on a program of “quantitative easing” – buying up financial assets across the eurozone to increase the supply of money. That could assist governments by driving down borrowing costs as well.
But so-called QE is fraught with potential legal trouble for the ECB – a European treaty forbids it from helping governments borrow.
In the case of Greece, the country is dependent on foreign bailout loans to pay its bills. A cutoff of aid over its inability to meet the loan conditions would leave it without any source of financing – and could push it to exit the euro so it can print its own money to cover its debts.
Germany’s economy minister, Phillip Roesler, said the prospect of Greece leaving the euro was now so familiar it had “had lost its horror” and that he was skeptical Athens would meet conditions for continuing rescue money.
The deteriorating situation follows a summit June 28-29 that many hoped would convince markets political leaders were getting a handle on things. The summit agreed on easier access to bailout money and to set up a single banking regulator that could take the burden of bank bailouts off national governments. Yet many of those changes will take months or years to introduce – and there has been no increase in bailout money.
It is an echo of a similar summit in July 2011, when leaders agreed on a second bailout and debt reduction for Greece, only to see borrowing costs spike dramatically as leaders headed off for August vacations.
Stephen Lewis, chief economist at Monument Securites Ltd, said that “events are following a pattern often repeated in the course of the eurozone’s troubles, in which the powers-that-be hail progress only to see confidence, almost instantaneously, plumb fresh depths.”