Why the Spain Bailout Package Won't Work

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The pricey Spain bailout package convinced markets it could fix the Eurozone debt crisis for only a moment Monday, before reality set in that the plan was far from ideal.

Following the announcement of a $126 billion (100 billion euro) bank rescue package, markets rose briefly. But the relief was short-lived as investors hastily refocused and remembered that the struggling Eurozone still faces a number of key obstacles.

The Dow Jones Industrial Average lost 142.97 points, or 1.14%, to close at 12,411.23.

Spain's bailout package was assembled swiftly as EU officials attempt to stave off suppositions about the country's sickly banks with crucial Greek elections just a few days away.

But it falls short of resolving what the Eurozone as a whole is up against.

Banking analysts at Societe Generale summed up in a note to clients, "The plan looks like a classic Eurozone fudge."

A "Spailout" Isn't Enough

The plan to rescue Spanish banks was initially globally applauded until it was revealed that details have yet to be finalized, such as exactly how much money the troubled banks will need.

While EU finance ministers did consent to provide up to $126 billion to the Spanish bailout fund to recapitalize insolvent banks, the amount needed will not be known until an external audit of the banks is finalized later this month.

Though the likelihood is very slim that the original amount is enough.

"The $126 billion agreed to over the weekend by EU finance ministers is a) not enough, and b) being bought by the same already-indebted-up-to-their-eyeballs Spanish banks," said Money Morning's Chief Investment Strategist Keith Fitz-Gerald. "This potentially adds another 10% to Spain's debt-to-GDP ratio and takes it up to an estimated 80% at the end of this year. This is going to make Spain's debt still more expensive (interest rates will rise) as international investors shun the very institutions that need the help."

How the loans will affect the Spanish government's credit rating is yet to be seen, although the salvage plan does not include any new austerity measures.

Spain's bailout package news came days after Fitch Ratings downgraded the nation's credit rating to BBB, one notch above junk status.

Spain's struggle goes way beyond its stressed banks. Its unemployment rate is currently a lofty 25%. And, while the country has a reasonably low level of public debt, the government has faced difficulty borrowing in the bond markets as investors insist on higher interest rates.

Fitz-Gerald added, "Europe should let Spain fail, just like they should have let Greece fail, Ireland fail, and others fail. All gain, no pain cannot and will not work. Capital markets are supposed to have failure; by removing it, you are merely shifting the pain deserved by irresponsible spenders to those that have been responsible."

The Debt Crisis Players: Italy, Greece, France

While Italy's deficit and unemployment are lower than Spain's, and its banks are not subjected to a real estate crisis, suspicion about Rome's ability to turn itself around during a deep recession are keeping international investors away.

Unrelenting market fears abound that Europe's third-largest economy could be the next to falter.

"According to Bloomberg, Italy has more than 2 trillion euros in debt all by itself," said Fitz-Gerald. "That's more than any other developed nation except Japan and, of course, Greece. That means Super Mario's government has to sell more than 35 billion euros in bonds a month. That is more than the entire annual national outputs of Cyprus, Estonia, and Malta – the EU's smallest three members."

Meanwhile, voters in Greece return to the polls Sunday after failing to form a coalition government. Worries abound that anti-austerity politicians will garner enough seats in the Greek Parliament to disrupt the bailout program Greece locked in earlier this year.

The looming anxiety is that Greece will exit the euro and return to the drachma. The potential ripple effect has global investors on edge.

"Regardless of the final outcome, there is a significant risk that these elections would lead to the creation of a weak short-term government, leaving the country leaderless and adrift," Wolfango Piccoli, a director at political research firm Eurasia Group, told CNN Money.

In addition, runoff elections are also being held Sunday in France. As CNN reported, the unease is that French President Francois Hollande's Socialist Party will not win the needed 289 seats to form a majority and will have to connect with the Left Front, which opposes government austerity measures.

This result would drag the French government further to the left and amplify divisions between Paris and Berlin over how to handle the euro crisis, Alastair Newton, a geopolitical analyst at Nomura Securities, told CNN.

In a sign that the markets doubt the Spain bailout package, the cost of insuring Spain's debt soared on Tuesday to a record high. The country's five-year credit-default swaps rose to 607 basis points, up from 595 basis points on Monday. That translates to an annual cost of $607,000 to insure $10 million in Spanish bonds.

"The way the market reacted indicates it can get messier," Fran Rodilosso, who helps manage global high-yield exchange-traded funds for Market Vectors, told MarketWatch. "People realize that any good news is not a final answer."

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