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The Euro sculpture is partially reflected in a puddle on a cobblestone pavement in front of the headquarters of the European Central Bank (ECB) in Frankfurt January 21, 2012. (Kai Pfaffenbach/Reuters)
The Euro sculpture is partially reflected in a puddle on a cobblestone pavement in front of the headquarters of the European Central Bank (ECB) in Frankfurt January 21, 2012. (Kai Pfaffenbach/Reuters)

After Spain's bailout, leaders fear for Italy's future Add to ...

Spain became the fourth euro zone country to seek a bailout, leaving some political and business leaders worrying that Italy, one of the world’s largest economies, might be next to fall victim to Europe’s deepening debt and banking crisis.

After weeks of denials and waffling, the Spanish government finally announced Saturday that it will request European Union financing for its ailing banks, a targeted bailout that would fall short of the full-blown sovereign bailouts that spared Greece, Ireland and Portugal from financial destruction in 2010 and 2011.

The announcement, by finance minister Luis de Guindos, came after a conference call of the finance ministers of the 17-country euro zone. The amount of the banking rescue was not revealed, though it is known the ministers were discussing a support package of as much as €100-billion, or about $125-billion U.S.

Mr. de Guindos said the final amount would be subject to an evaluation of Spanish bank capital requirements by two independent consulting firms.

“The amount requested will be enough to cover the necessary capital plus a significant margin,” he said, adding that “it will be specifically for the financial system only.”

In research published Friday, Deutsche Bank presented an “intermediate” scenario that would see €80-billion pumped in the banks, many of which are groaning under the weight of dud loans made to the boom-turned-bust housing and construction sectors. Their collapse triggered a deep recession, the highest jobless rate on the continent and a change of government.

The bailout came after Italian Prime Minister Mario Monti, at a conference on Italian-U.S. relations in Venice on Friday, said “There is a permanent risk of contagion, contagion from Greece, from other countries. That is why strengthening the euro zone is of such collective interest.”

At the same conference, Sergio Marchionne, the Italian-Canadian CEO of Fiat and Chrysler, said a breakup of the currency union is possible. “I think someone had better do something before we get to the point of no return,” he said.

Italian bond yields, which had dipped earlier this year under Mr. Monti’s austerity and economic reform program, have climbed sharply recently as the crisis in Greece and Spain gained momentum.  While Italian banks do not appear to be in as rough shape as Spain’s, they have lost enormous amounts of stock market value and Italy is Europe’s most indebted country, with debt to gross domestic product ratio of 120 per cent. Italy is also grappling with a new recession.

Some economists think that Spain’s banking bailout will not trigger alarm among investors when the markets open Monday morning. The bailout came as no shock, in good part because Spanish treasury minister Christobal Montoro on Tuesday admitted the country was in trouble, saying on Spanish radio that “The risk premium [on Spanish bonds] says Spain doesn’t have the market door open.”

In spite of the warning, Spain succeeded in selling new sovereign bonds on Thursday, though at a higher cost than previous auctions. “Thursday morning’s fairly satisfying bond auction may suggest that the market, at least for now, is viewing positively the prospects of a ‘bank recap only’ loan to Spain, though anticipations of a more comprehensive euro crisis strategy to be unveiled at the European summit on June 28/29 are also playing a role,” said Deutsche Bank economist Gilles Moec.

The source of the bailout for Spain’s banks was not known Saturday, thought it was confirmed that the International Monetary Fund, which has co-sponsored the rescues of Greece, Ireland and Portugal, would only play a consulting role in the Spanish effort.

Two likely sources are the Euro zone’s current rescue fund, the €440-billion European Financial Stability Facility, or the new European Stability Mechanism, which comes into formal existence next month, with €500-billion. It is possible that the Spanish bank rescue could come from a combination of the two.

The funds would be injected into Spain’s existing bank-rescue fund, known by its Spanish initials as FROB. The fund has been tapped to pump up the capital of many regional savings banks. The biggest single trouble spot in the Spanish banking industry is Bankia, the fusion of several weak savings banks, that requires €19-billion in fresh capital. Like many rival banks, it was hit hard by the property bust.

The banking bailout is not expected to come with tough new conditions, largely because the Spanish economy is already being hit by tough austerity measures demanded by Brussels. In a statement Saturday, the finance ministers, known as the Eurogroup, said “The Eurogroup is confident that Spain will honour its commitments under [EU budget rules]. Progress in these areas will be closely and regularly reviewed also in parallel with the financial assistance.”

Even though the bailout will be directed only at the banks, the amount will have to be guaranteed by the Spanish government and will land on the government’s books, boosting the national debt considerably. Assuming a €80-billion bailout, the debt-to-GDP ratio would rise to a fairly hefty 95 per cent. That is above the EU average, but still well short of Italy’s 120 per cent.

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