Europe Frets: Will Spain Need Full Bailout?

Europe is on the brink again. The crisis over too much debt in the 17 countries that use the euro flared dangerously on Monday.

Fears that Spain was next in line for a full-blown government bailout intensified following a weekend of bad news about the country's economy. Madrid's borrowing costs on its 10-year bonds — an indicator of market confidence in a country's ability to manage its debt — hit an alarming record of 7.56 percent during morning trading, pushed up by reports that the country's indebted regions might join its banks in requesting expensive bailouts.

Stocks slid. Germany's DAX plunged 2.7 percent. Britain's FTSE was off 2 percent and France's CAC 40 fell 2.5 percent. The euro slipped just below $1.21 against the dollar, its lowest reading since June 2010.

Concern over Spain increased Monday after the country's central bank said the economy had contracted by 0.4 percent during the second quarter. The government predicts the economy won't return to growth until 2014 as new austerity measures hurt consumers and businesses.

On top of that, Spain is facing new costs as its regions join the banks and ask the federal government for assistance. The country has already asked for a eurozone bank bailout package of up to €100 billion ($121 billion), and the government is ultimately liable to repay the money.

Yet it is far more than just Spain's struggle.

Greece, already into its second bailout and struggling to keep its membership in the currency bloc, faces tense negotiations with international creditors over its attempts to reform its economy. A team of officials from the European Commission, European Central Bank and the International Monetary Fund arrive Tuesday.

Borrowing costs also rose in Italy, which has been caught up in fears that it may soon be pushed into asking for aid. Italy's economy is stagnating and markets are worried that it may soon not be able to maintain its debt burden of €1.9 trillion ($2.32 trillion) — the biggest in the eurozone after Greece and the world's third-largest bond market after the United States and Japan.

The collapse in share prices prompted Italy and Spain to introduce temporary bans on short-selling — a practice where traders sell stocks they don't already own in the hope they can make a profit if the stock falls in price.

Pascal Lamy, director of the World Trade Organization, said the situation in Europe is "difficult, very difficult, very difficult, very difficult."

"It's obviously the major challenge in the weeks and the months to come, for the Europeans but also for the rest of the world which is extremely worried," he said after a meeting with French President Francois Hollande.

A Spanish bailout or Greek exit threatens market turmoil that could squeeze credit throughout the world. It could also hurt trade with an important partner for the U.S. and Asia.

Ireland, Greece and Portugal have already taken bailout loans after they could no longer afford to borrow on bond markets. Yet those countries are tiny compared to Italy and Spain, the third- and fourth-largest economies in the eurozone. Analysts say a full bailout for both could easily exceed the other eurozone countries' financial resources.

Spain has already received a commitment of up to €100 billion from other eurozone countries to bail out its banks, which suffered heavy losses from bad real estate loans. Eurozone finance ministers signed off on the aid Friday and said €30 billion would be made available right away. But that incremental step cuts little ice with investors. If Spain's borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue.

"Events since Friday have been a clear wake-up call to anyone who thought that the Spanish bank rescue package had bought a calm summer for the euro crisis," analyst Carsten Brzeski said.

The eurozone's bailout fund, the European Stability Mechanism, has only €500 billion in lending power, with €100 billion potentially committed to Greece. Italy and Spain together have debt burdens of around €2.5 trillion. And the ESM hasn't yet been ratified by member states plus eurozone governments have made it clear they won't put more money into the pot.

That once again pushes the European Central Bank into the frontline against the crisis.

On Saturday, Spain's Foreign Minister José Manuel García Margallo pleaded for help, saying that only the European Central Bank could halt the panic. But the ECB has shown little willingness to restart its program to purchase the government bonds of financially troubled countries. The central bank has already bought more than €200 billion in bonds since May 2010, with little lasting impact on the crisis.

The central bank has also cut the rate it lends to banks to a record low of 0.75 percent in the hope of kick-starting lending. Yet many economists question how much stimulus this provides as the rates are already very low — and no one wants to borrow anyway.

There has been speculation the ECB could eventually have to follow the Bank of England and the U.S. Federal Reserve and embark on a program of "quantitative easing" — buying up financial assets across the eurozone to increase the supply of money. That could assist governments by driving down borrowing costs as well.

But QE is fraught with potential legal trouble for the ECB — a European treaty forbids it from helping governments borrow.

In the case of Greece, the country is dependent on foreign bailout loans to pay its bills. A cutoff of aid over its inability to meet the loan conditions would leave it without any source of financing — and could push it to exit the euro so it can print its own money to cover its debts.

Germany's economy minister, Phillip Roesler, said the prospect of Greece leaving the euro was now so familiar it had "had lost its horror" and that he was skeptical Athens would meet conditions for continuing rescue money.

The deteriorating situation follows a summit June 28-29 that many hoped would convince markets political leaders were getting a handle on things. The summit agreed on easier access to bailout money and to set up a single banking regulator that could take the burden of bank bailouts off national governments. Yet many of those changes will take months or years to introduce — and there has been no increase in bailout money.

It is an echo of a similar summit in July 2011, when leaders agreed on a second bailout and debt reduction for Greece, only to see borrowing costs spike dramatically as leaders headed off for August vacations.

Stephen Lewis, chief economist at Monument Securites Ltd, said that "events are following a pattern often repeated in the course of the eurozone's troubles, in which the powers-that-be hail progress only to see confidence, almost instantaneously, plumb fresh depths."

(The Associated Press 2012)