European Union finance ministers have agreed to recapitalize Spanish banks by injecting at least 100 billion euros ($125 billion) into the financial system. The action came after a reluctant Spanish government was finding it increasingly difficult to refinance its debt and gave in to what most observers believe was inevitable; a humiliating bailout by the EU.
The bailout is already roiling the Greek parliamentary election scheduled for next Sunday as anti-bailout forces are seeking to make political capital out of the bailout. A victory by the far left would almost guarantee a Greek exit from the euro and chaos in Europe’s financial sector. Other nations who have been bailed out by the EU may seek to renegotiate their agreements following what some observers believe are generous conditions given to Spain for their bailout.
Spanish pride may be wounded, but the government had little choice. The increasing costs of financing its debt and revelations about the weakness of the banking sector coupled with the potential shock of a Greek exit from the euro made recapitalization of Spain’s financial sector of paramount importance. A run on Spanish banks might bring the entire economy down and the EU emergency funds are inadequate to deal with a bailout of a country whose economy is the fourth largest in Europe.
As recently as last Tuesday, Spanish government officials denied that a bailout was necessary or imminent. But the growing crisis in financing Spanish 10-year government bonds, with yields soaring close to the 7% danger level, forced the government to admit over the weekend that the problem was too big to be solved by Madrid alone and that Spain should seek aid from its EU partners.
Spain joins Ireland, Portugal, and Greece as nations being forced to seek help from the EU. As a sop to Spanish pride, the money will be funneled through a government emergency bailout mechanism, the Fund for Orderly Bank Restructuring (FROB) so it is not considered direct aid to Madrid. Spain’s troubled banks were giving investors pause and it is believed that the bailout will steady the markets and inject liquidity into the banking system. This, in turn, will keep the Spanish economy afloat, despite the 24% unemployment, the second recession in three years, and a contraction of the economy this year that may reach 2%.
It is still to be decided exactly how the bailout will work. Spanish banks may tap the European Financial Stability Facility, a 440 billion euro emergency fund. There is also a possibility that the new 500 billion euro European Stability Mechanism could be accessed – or a combination of the two. The assistance would come in the form of bonds that the banks could then use as collateral to borrow cash from the European Central Bank. The resulting infusion of liquidity will, it is hoped, unfreeze credit markets.
The writing was on the wall last month when Spain’s 4th largest bank and the biggest holder of Spanish mortgages, Bankia, was taken over by Madrid and 20 billion euros was pumped into the corporation. The housing and real estate bubble that burst in 2008 has flattened the housing sector in Spain, and Bankia, which reported a profit of 309 million euros in 2011, was bleeding red ink. A re-examination of the books actually showed a 4 billion euro loss in 2011, with potential bad loans totaling almost 40 billion euros. While it is believed most of Spain’s international banks are in good shape, smaller regional banks are carrying up to 185 billion euros in bad mortgages. Hence, the bailout, which will more resemble a line of credit for these banks rather than a straight infusion of cash.
It was originally believed that Spain would wait to ask for a bailout until an independent audit of its banks was completed and published on June 21. But when yields on Spanish bonds rose to 6.78% last week, it became clear that the government couldn’t wait. Over the weekend, EU finance ministers agreed to a recapitalization plan after a request for assistance from Spanish Economy Minister Luis de Guindos at a news conference. Guindos told reporters, “The Spanish government declares its intention of seeking European financing for the recapitalization of the Spanish banks that need it.” The IMF is conducting its own survey of Spanish banks and that report will be out this week. Rather than wait until after the Greek election for the results of the audit, EU finance ministers gave the go ahead for Spain to use the IMF numbers for the plan.