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.
De Guindos' announcement didn't sit well with the Spanish people. A hashtag on Twitter sprouted that expressed the feelings of many in Spain: #rajoycobarde (Rajoy coward). While leaving Guindos to face the press, Rajoy jetted off to Gdansk, Poland to watch the Spanish national soccer team play in the European championships. A recent poll shows Rajoy's approval dropping to 37% while unhappiness with his government's policies approaches 65%.
The bailout will throw up a firewall for Spanish banks ahead of the Greek elections on June 17 which may bring to power a government unwilling to carry on with the austerity measures demanded by the EU, the European Central Bank, and the International Monetary Fund, which negotiated a $172 billion bailout of Greece last spring. That eventuality would lead to a cutoff in aid and an almost certain Greek default -- a turn of events that would drive Athens off the euro and back on the drachma with consequences that would almost certainly threaten the stability of the Spanish banking sector.
Prime Minister Mariano Rajoy tried to put the best face on the humiliation. He refused to use the term "bailout" when discussing the bank rescue during his news conference on Sunday, saying "Europe is offering Spanish banks a credit line that they will have to pay back.…There is no macroeconomic conditionality for the country, but for the banks that receive it." In fact, he denied any such thing as a bailout was occurring, adding, "If we hadn't done what we've done in the last five months, we would have been discussing yesterday a bailout for the Kingdom of Spain," he said.
Elsewhere, the bailout was making waves with other nations who received EU cash in return for harsh austerity measures. In Ireland, opposition finance spokesman Michael McGrath criticized his government for having failed to negotiate better conditions on their bailout, saying it needed "to start fighting Ireland's corner in a more vigorous and forceful way." Sinn Fein's finance spokesman Pearse Doherty said "Many Irish people looking at the deal this morning will be asking themselves why is there one set of conditions for us and another for Spain."
But real trouble is brewing in Greece where the radical socialist Alexis Tsipras, leader of the far-left SYRIZA coalition, is seeking to make political hay out of the generous terms given to Spain. Tsipras, who is telling voters they can ignore austerity demands by the EU and still remain in the euro zone, said, “The developments in Spain confirm the position we adopted from the start – that the crisis is a pan-European problem, and the way it has been handled so far has been socially catastrophic and completely ineffectual.” Even the pro-bailout parties have been forced by political necessity to promise to renegotiate some of the harsher terms of the agreement. Not surprisingly, spokesmen for the EU, the ECB, and the IMF have all rejected that notion.
Early Monday, world markets reacted favorably to the Spanish bank bailout, easing fears of a fiscal crisis that would spread to other countries and cause a meltdown similar to the one that brought about the Great Recession in 2008. But the rally may be shortlived. With Greece on the edge of political chaos, fears of what might happen if Athens is forced to leave the euro zone could ratchet up the tension once again and endanger the shaky financial system along the entire southern periphery of the EU.
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