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A woman makes a transaction at an ATM machine outside a Eurobank branch in Athens. That Greece is hurtling towards the euro zone’s exits has been accepted, and apparently fully discounted, by the markets. Far more worrisome is the rapid deterioration of the Spanish economy and its banking system (JOHN KOLESIDIS/REUTERS)
A woman makes a transaction at an ATM machine outside a Eurobank branch in Athens. That Greece is hurtling towards the euro zone’s exits has been accepted, and apparently fully discounted, by the markets. Far more worrisome is the rapid deterioration of the Spanish economy and its banking system (JOHN KOLESIDIS/REUTERS)

Eric Reguly

Investors fear Spain spiralling toward bailout Add to ...

Spain is now in the eye of the euro storm but, unlike Greece, Ireland and Portugal, may be too big to save.

Its banks and economy have deteriorated at an alarming rate, to the point that the European Commission has offered to ease the country’s austerity targets amid the threat of “financial disintegration” in the region.

Spain’s soaring bond yields, waning economy and the highest jobless rate on the continent have spooked investors, politicians and European Union officials. Their fear is that Spain may require a bailout or rescue program that Europe’s biggest economy and paymaster – Germany – will reject. Germany has resisted almost every measure that deviates from its austerity-for-all agenda. It does not support a pooling of debt through euro bonds or boosting the firepower of the €500-billion ($635-billion) European Stability Mechanism (ESM), the permanent rescue fund.

<p> “The common thread linking Greece, Ireland and Portugal was the fact that they were all relatively small economies in the grand scheme of the European project,” said Rupert Osborne, futures dealer at IG Index in London. “Yet now the crisis looks to have Spain firmly in its grasp, a country that is possibly too big too save.” </p> <p> Spain is the fourth-largest economy in the 17-member euro zone, after Germany, France and Italy. Economists and European political leaders fear that the cost of fixing the Spanish banks, still suffering from Europe’s biggest housing collapse in 2008, could overwhelm the country, forcing it to take a bailout. </p> <p> “Even if, by some miracle, public sector spending and revenues are brought into closer line, the progress on government debt could be swamped by the costs to public coffers associated with bank recapitalizations,” the CIBC World Markets economics team, led by Avery Shenfeld, said in a research note. </p> <p> CIBC noted that Ireland’s €400-billion guarantee scheme for its banks was so costly that it ultimately triggered an Irish bailout, even though the country’s overall debt load was relatively small. “In this regard, Spain risks following the path of Ireland,” the bank said. </p> <p> Spain’s banking crisis deepened this week when the European Central Bank reportedly rejected the Spanish government’s unusual plan to recapitalize Bankia, the new banking group created by the forced amalgamation of several ailing regional banks. Madrid wanted to inject €19-billion of sovereign bonds into Bankia’s parent company, which would then be swapped for cash at the ECB’s refinancing window. </p> <p> According to various reports, the ECB rejected the plan because it would breach “monetary financing,” that is, central bank funding of governments. </p> <p> On Wednesday, as global markets tumbled, Olli Rehn, the European Union’s top economics official, said the EC is “ready to propose an extension” of Spain’s fiscal adjustment program as it struggles to crunch its budget deficit. It was the EC’s strongest hint that the harsh austerity programs, condemned as job killers by Spain, France, Italy and Greece, may be causing more economic harm than good. </p> <p> Bond yields in Spain and Italy soared, taking borrowing costs ever closer to the crisis levels that triggered the bailouts of Greece, Ireland and Portugal in 2010 and 2011. The flight of capital from the Mediterranean countries to the northern havens pushed yields of benchmark German bonds to a record low of 1.27 per cent. Spanish yields climbed to 6.65 per cent, putting them dangerously close to the 7-per-cent level that many economists consider unsustainable. </p> <p> With the Spanish economic and banking crisis getting worse by the day, raising doubts about its ability to stay within the euro zone, the EC is willing to ease up on the austerity campaign that has in part been blamed for sending the country’s unemployment to 24 per cent, and the youth jobless rate to more than 50 per cent. </p> <p> The new program would allow Spain to reduce its budget deficit to 3 per cent by 2014, one year later than planned. The deficit last year was 8.9 per cent, one of the highest in the euro zone. </p> <p> In its 1,000-page report on the state of the EU economy and its proposals to return it to economic health, published Wednesday in Brussels, the EC (the EU’s executive arm) would allow the ESM rescue fund to capitalize the banks directly. Currently, banks can only be rescued through national governments. When that happens, sovereign debt levels rise, potentially to the point of scaring off bond investors. </p> <p> The EC is also lobbying for a “banking union” that would guarantee deposits throughout the 17 countries that use the euro – deposit insurance schemes are purely national currently. It also wants a common bank bailout fund and supports euro bonds, which would reduce the borrowing costs of the weakest countries by exploiting the triple-A credit ratings of Germany. </p> <p> “To counter this trend of financial disintegration, more co-ordination at European level is required in supervision and crisis management frameworks,” the EC report said. “More specifically, closer integration among the euro area countries in supervisory structures and practices, in cross-border crisis management and burden sharing, towards a ‘banking union’ would be an important complement to the current structure of monetary union.” </p> <p> However, observers don’t expect the idea will fly. </p> <p> “This is still the only viable method of solving the crisis, but for some unfathomable reason, the Germans aren’t too keen on – as they must see it – throwing good money after bad,” said Mr. Osborne of IG Index. “Unless they change their minds, this crisis is only going to end one way.” </p>

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