So far, their actions suggest they’re sticking with the strategy they pursued in Greece and expecting different results. They’d better think again.
The agreement last weekend to provide as much as 100 billion euros ($125 billion) to Spain’s banks shows Europe’s leaders are at least beginning to recognize the magnitude of the task. The amount matches some of the higher estimates of the capital the banks will need to offset heavy losses related to Spain’s real estate bust. As such, it might help inspire the confidence necessary to slow the flow of money out of the country and lower the odds of an all-out bank run, particularly if Sunday’s Greek parliamentary elections set that country on a path to leave the euro.
The deal, though, fails to address a fundamental issue that has been spooking markets: This is the worst possible time for Spain to borrow 100 billion euros. Under the agreement, any amount used to bail out Spain’s banks will be added to the country’s government debt, potentially pushing it to a net 70 percent of gross domestic product, from about 60 percent today. Spain is already struggling to sell its government bonds to anyone other than its own banks; the sudden increase in debt could completely cut it off from private financing.
Market LockoutA market lockout would force Spain to ask the troika -- the European Union, the European Central Bank and the International Monetary Fund -- for the money it needs to cover its budget deficit, one of the euro area’s largest. If Greece is any indicator, that assistance would come with tough conditions, requiring Spain to exercise extreme austerity as its economy is mired in recession and its unemployment rate is approaching 25 percent. The Greek fiasco shows how well that works.
Investors recognize the flaws in Spain’s bank bailout deal. Even as the European stock market surged yesterday, Spain’s borrowing costs rose. The yield on the 10-year bond stood at 6.47 percent Monday afternoon, up from 6.17 percent Friday.
Watching Spain’s predicament worsen is particularly galling because the country is solvent and capable of solving its problems. The government, on its own, is moving to put in place the structural reforms needed to boost long-term growth potential, such as making it easier to fire and hire workers. If the economy returned to moderate growth in the coming years and the government managed to turn its budget deficit into a small surplus (not counting debt payments) by 2018, it could stabilize its debt load.
To make Spain’s recovery possible, Europe must break the link between the banks and the government. Instead of lending the money for recapitalization to the sovereign, Europe’s bailout funds should agree to inject it directly into the banks -- as Bloomberg View has advocated. In return, European regulators should have a say in how management would be punished, and whether dividends and bonuses would be paid, at institutions that accepted the money.
That alone won’t be enough. The recapitalization should be part of a larger process that would forge a common euro-area approach to dealing with troubled banks, require private bank creditors to share in losses, consolidate the debt of euro-area governments and create a mechanism to stimulate growth in hard- hit economies such as Spain. A euro-area unemployment fund, for example, could accelerate much-needed labor-market reforms and boost Spain’s GDP growth by as much as 2.5 percentage points at a cost of about 25 billion euros a year -- an expense that would shrink as the added growth put people back to work.
Any of these actions would require the euro area to do something its most powerful member, Germany, has so far resisted: accept collective responsibility for the currency union’s survival. Spain’s predicament makes such a shift in strategy imperative. If Europe’s leaders can’t commit, this most recent gesture will only delay the inevitable, and the global economy will suffer the consequences.