Europe’s desperate attempt this weekend to shore up the Spanish banking system with a €100 billion loan ahead of the all-important Greek parliamentary elections on Sunday, June 17 appears to have backfired. For rather than restoring investor confidence in Spain, it appears to have done the exact opposite. This is evidenced by a spike in Spanish 10-year government borrowing rates to over 6.5 percent, which is more than 5 percentage points more than the German government has to pay.
Far from reassuring foreign investors, the European loan of €100 billion to the Spanish government’s Bank Restructuring Fund has underlined to investors how large was the capital shortage in the Spanish banking system. It has also reminded investors how fragile are Spain’s public finances. Since this loan, which amounts to around 10 percentage points of Spain’s GDP, puts Spain’s public debt on a path to now exceed 90 percent of Spain’s GDP by the end of 2012.
With the Spanish economic recession deepening, investors are understandably increasingly concerned about the prospects for Spain to reduce its budget deficit of around 9 percent of GDP without deepening its economic recession. This is especially the case given Spain’s euro straitjacket, which prevents it from cheapening its currency to boost exports, and given the fact that its economy is now in the full throes of a housing market bust. Yet another market concern is that the European loan to Spain will enjoy senior status, which will subordinate private sector claims on the Spanish government.
A further unintended consequence of Europe’s Spanish bank bailout loan is that it has increased Prime Minister Rajoy’s resistance to a full scale IMF-EU bailout. This is all too likely to delay any full scale IMF-EU bailout of the country, which it now sorely needs. It is also likely to set the stage for a further weakening in the Spanish government’s credibility at home when in the end markets force Spain to go cap in hand to the IMF and EU to obtain a bailout for the Spanish government.
Yet a third unintended consequence of the Spanish bailout goes beyond Spain’s borders. It is raising serious questions in both Portugal and Ireland as to why Spain is getting preferential treatment in the sense that it is receiving European bailout money without being subject to the strict IMF conditionality to which Portugal and Ireland are being subjected. It is also seemingly increasing the appeal of Alexis Tsipras, the head of Greece’s radical left party, to Greek voters ahead of Sunday’s Greek elections with the argument that the way to wring concessions out of the Germans is to stand up firmly to them when they ask for increased austerity.
When the history of the euro’s unraveling is finally written, this €100 billion will be seen as yet another example of policy improvisation without a clear long-term strategy to defuse the crisis and without careful thought having been given to possible unintended consequences. It will also be remembered as another sobering indication of how the half-life of European band aid solutions is getting shorter with each time they are tried.