Massive bailout for Spain may only be stopgap measure

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By Paul Taylor, Reuters

ANALYSIS
 PARIS -- Euro zone finance ministers rushed Spain into an EU-funded rescue for its debt-stricken banks to pre-empt the threat of a bank run if Greece's debt crisis flares again but any respite for Madrid and the euro may be short-lived.
After weeks of insisting that Spain needed no assistance to recapitalise lenders crippled by bad debts from a burst real estate bubble, Prime Minister Mariano Rajoy was pushed into requesting an aid package for fear of worse disaster to come, European officials involved in the negotiations said.
The 17-nation currency area agreed to lend Madrid up to 100 billion euros ($125 billion) for its bank rescue fund, more than an initial audit suggests it is likely to need, in an attempt to reassure investors and erect a new firewall in the crisis.
But the euro zone's latest line in the sand, after bailouts for Greece, Ireland and Portugal since 2010, could be swept away as early as next Sunday by angry Greek voters, rekindling market turmoil that would hit Spain and Italy first.
Rajoy said his reforms had spared Spain a full rescue for its public debt but some analysts say the bank aid may only be a prelude to an eventual bailout of the state.
After less than six months in office, the conservative premier is desperate to avoid that stigma, while other European leaders are just as desperate to avoid the cost, which would stretch the euro zone's rescue funds to the limit.
Unicredit chief economist Erik Nielsen said once the banks had been recapitalised, "they have basically addressed the three key weaknesses: banks, regions, and structural weaknesses".
Others are less confident.
"The burden of recapitalising insolvent banks or loss-making acquisitions of solvent banks will fall on Spanish citizens," said Karl Whelan, economist at University College, Dublin. "For this reason, this weekend's announcement may well end up shutting Spain out of the sovereign bond market."
The euro zone's fourth largest economy is beset by recession and mass unemployment and still has a weight of national and regional debt to roll over later in the year, although it has got through 58 percent of its borrowing for 2012.
Moody's Investor Service said last week the debts of euro area sovereigns dependent upon official funding present "non-investment grade risks", prefiguring a likely cut in Madrid's credit rating. Fitch Ratings slashed Spain by three notches to BBB last week - just above junk status.
The government still needs to refinance 47.3 billion euros of debt maturing by the end of the year, with a big hump at the end of October, and Spain's overspending regions have a further 15.7 billion euros of debt maturing in the second half of 2012.
"We're very close to junk bonds and we'll end up in the junk," Jose Carlos Diez, chief economist at Intermoney in Madrid, said on Spanish television.
"In this situation, the key is to look at the reaction of investors and see if capital flight stops ... If the process doesn't stop, there will be more funding problems and what we will see is a bailout that is starting small become a big one."
Greek countdown
Policymakers feared that what has been termed a "bank jog" from Greece and Spain could turn into a stampede if anti-austerity leftist parties opposed to the terms of Athens' EU/IMF bailout win the June 17 vote.
If leftist SYRIZA party leader Alexis Tsipras tops the Greek poll and forms a government, he has said he will tear up the bailout agreement and demand a renegotiation. That would likely prompt the euro zone and the IMF to suspend aid payments, leaving Greece to default by September, EU sources say.
Although Athens could not be legally forced to leave the euro area, it would lose access to external funding for the government and the banks, plunging it into chaos.
Capital flight from Spanish banks has reached euro lifetime record levels, with a net outflow of 66 billion euros in March, the most recent month for which figures are available. That was before the government's sudden, fumbled nationalisation of teetering lender Bankia.
Despite Rajoy's denial that he was pressured, Germany and France, Europe's two leading powers, as well as the European Central Bank, the European Commission and the IMF leaned heavily on Madrid to request aid before the Greek general election.
A senior German official said Berlin had warned the Spanish government if it did not seek help for the banks now, it risked having to apply for a full-fledged country bailout later.
"Spain is better off in a safe shelter," the official said, adding that the timing before the Greek vote was vital.
Chancellor Angela Merkel publicly praised Rajoy's fiscal and labour market reforms and said Spain did not need to implement any deeper austerity measures in return for help.
French President Francois Hollande, keen to avoid euro zone panic as he seeks a parliamentary majority in elections this Sunday and next, also applied pressure for a swift bailout.
"France was keen to see an agreement this weekend, to resolve the situation as soon as possible, but I was not the only one to say that," Economy Minister Pierre Moscovici told Reuters hours after a tense 2-1/2-hour conference call of finance ministers over how to help Spain.
U.S. President Barack Obama telephoned Merkel, Hollande and other senior European leaders last week to press for urgent action to stem the euro zone crisis, which poses a threat to the U.S. recovery and hence to his re-election. Japan, Britain, Canada and the International Monetary Fund all weighed in.
U.S. Treasury Secretary Timothy Geithner called Saturday's decisions "concrete steps on the path to financial union, which is vital to the resilience of the euro area".
Italy next?
Aside from the global pressure to stabilise the currency area, Berlin and Paris acted out of self-interest.
"If Spain got into a castastrophic situation, you could forget French and German banks," Luxembourg Finance Minister Luc Frieden told broadcaster RTL on Sunday.
Stress has risen again on financial markets as the effects of the ECB's injection of 1 trillion euros ($1.25 trillion) in long-term cheap loans into euro zone banks in December and February have worn off.
"It feels as if it is just a matter of time before more issues will erupt, especially if growth remains sluggish," Morten Spenner, CEO of fund of hedge fund manager International Asset Management told Reuters. "To that end, a more holistic and much deeper political and financial solution is ultimately required rather than a continue band-aid by band-aid approach."
ECB President Mario Draghi acknowledged last week that the interbank market in Europe was "dysfunctional". Many southern European banks are shut out and totally reliant on central bank money.
Investors will be concerned that if the European Stability Mechanism is used to fund the Spanish package, as Germany prefers, bondholders will be subordinated to the permanent euro zone rescue fund and face potential losses in any restructuring, said Gary Jenkins of Swordfish Research.
"Considering that sovereign support for Greece required private sector involvement it would be a bit of a turn up for the books if the equivalent for (Spanish) banks did not involve PSI (private sector involvement)," he said.
Frieden said the ministers had deliberately agreed on a big headline number for Spain to show markets they could meet any eventuality, and he did not believe all the money would be used.
"In my opinion it will not be the 100 billion, so we have built in a safety margin so that if the expert analysis concludes that a high amount will be needed, it is available."
Spain debt deal will likely give stocks a boost Monday
The Spanish rescue package was also intended to relieve pressure on Italy, the No. 3 euro zone economy.
Some market participants see Rome, which has Europe's highest debt ratio after Greece but a low budget deficit, as potentially next in line for a bailout which the euro zone could ill afford.
"Where next? 200 or 300 billion euros for Italy? (The Spanish bailout) is just compounding the agony," said Nick Hocart, a director at currency fund manager Xenfin in London.
Economists at Citi said Italy faced rising debt for a prolonged period and "will most likely require some form of intervention".

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