From The New York Times
As Spain’s economic crisis deepens and uncertainty swirls over Greece’s future in the euro zone, the guardians of the increasingly fragile European monetary union are near a moment of truth: Can they muster the will and resources to keep the euro zone from breaking apart?
The question has grown more urgent since the release of data Friday showing a record-high rate of unemployment in the euro zone, poor job creation in the United States and a manufacturing
slowdown in China. Combined, those signals have fueled fears of a second global recession
On consecutive days last week, two of the most powerful figures in Europe — Mario Draghi, president of the European Central Bank, and Olli Rehn, the most senior economic official in Brussels — warned that the future of the euro zone was in doubt. In the words of Mr. Rehn, the union might well disintegrate unless policy makers took steps to bind the euro
’s 17 nations closer together.
Coming as they did from two men at the very soul of the European project, the reprimands were a stark reminder of just how much the Spanish financial meltdown had shaken the confidence of the European brain trust, to say nothing of investors from New York to Beijing.
Over the weekend, leaders of two of the euro’s most vulnerable countries rallied to the cry of more unification. Mario Monti of Italy called for using euro bonds to create a quicker path to common debt for Europe. And Mariano Rajoy of Spain floated the idea of a common fiscal authority in Europe to synchronize budgets and manage debts.
But as global economic gloom deepens, there is a risk that such lofty talk could be too little, too late for investors, especially with Spain seeming on the brink of a banking collapse.
Sitting as Spain does on an estimated €220 billion, or about $273 billion, in failed real estate loans alone — a number that surpasses the entire output of the Greek economy — there is little doubt that Spain, with the fourth-largest euro zone economy — behind Germany, France and Italy — is too big to fail. Or, more precisely, to be allowed to fail.
Indeed, many investors and money managers now see Europe’s challenge as not how to bail out sickly Spanish banks, but how to keep Spain and even Italy afloat and in the euro zone as money keeps leaving these countries, forcing interest rates up and leaving flaccid local banks as the only buyers of government debt.
“The euro zone is disintegrating and this has started to feed into institutional capital flight out of the euro zone,” said Jens Nordvig, a senior bond and currency specialist at Nomura in New York. “The crisis has reached a new level. Policy makers are realizing that there are only two options. Further integration or a breakup.”
Arriving at an action plan and amassing the cash to back it up will be no easy matter, though. Analysts guess that a comprehensive rescue for Spain would cost €350 billion, and one for Italy would cost even more. Sums that large would quickly overwhelm the €500 billion available in the new European rescue fund, the European Stability Mechanism.
Integration, in the form of banking and fiscal unions, would take time, of course, although policy makers are pushing harder than ever on these fronts. As for short-term measures that countries like Spain are pushing for, namely to get Europe to provide money for its banks or buy its bonds in bulk, these steps would require sacrifices that Spain seems in no mood to make.
It is the nub of the euro zone’s existential quandary: how to get taxpayers in northern creditor countries like Germany to provide funds to countries like Greece and Spain that are unwilling to accept the loss of sovereign control over their banks and budgets that would be the consequence of such assistance.
“Spain wants the money to bail out its banks, but it does not want the conditions,” said Charles Wyplosz, an international finance expert at the Graduate Institute in Geneva. “But at the end of the day, they will have to accept conditionality because, for now, these are the rules.”
Analysts estimate that the amount needed to backstop failing Spanish banks is €60 billion to €80 billion, which on the face of it could come from Europe’s rescue fund.
The sticking point is that Spain wants Europe to inject money directly into these banks, as in the bank-bailout program in the United States in 2008 and a similar effort by the British government.
Germany, however, has no desire to swallow the bill for Spain’s bad banks, so it is insisting that funds be disbursed to the Spanish government and that strings be attached. It wants more draconian spending cuts and perhaps even losses for the mostly Spanish investors who hold the stocks and bonds of these failed banks. But as Berlin and Brussels butt heads with Madrid over who pays what, when and how, money continues to flee from Spain at an alarming rate.
According to figures from the Spanish central bank, €66 billion left the country in March as investors sold Spanish stocks and bonds with abandon. And in April, the outflow of deposits from Spanish banks also picked up, with €31 billion leaving the Spanish banking system, according to the European Central Bank.
Simply put, the number of investors willing to hold Spanish assets of any kind is shrinking by the day. Moreover, with many money managers now concluding that Greece will return to the drachma after elections June 17, the attack on Spain has broadened into an attack on the euro itself, as reflected by the currency’s precipitous fall to a two-year low of 1.23 against the dollar
“The market is massively short Europe,” said a hedge fund trader based in London not authorized to speak publicly. “There is just a feeling that it’s too late for steps like deposit guarantee schemes to help Greece or Spain.”
In particular, analysts are looking ahead to a Spanish bond auction of about €2 billion set for Thursday. The sale is expected to include 10-year bonds. There are doubts that banks, in the current environment, will jump to buy such long-term paper, given the increased risks in holding Spanish debt. Even yields nearing 7 percent may not lure them.
Of course, for financial professionals, it is easy to expect the worst when all day long the screens in front of you show persistent losses.
Some experts said, though, that it would be a mistake to underestimate European resolve about ramming through unifying measures like euro bonds and tighter common control of national budgets — especially when the prospect for not doing so looks so dire.
“The bet by investors has always been that the policy response from Europe would not be enough to keep countries in the euro,” said Douglas Rediker, a former member of the executive board of the I.M.F. who is now at the New America Foundation in Washington. “But the measures being discussed today — harmonized banking regulation, bank deposit guarantees and euro bonds — were not even on the table two years ago.”
Mr. Rediker is not necessarily predicting a big bailout for Spain. But he says that for such a rescue to be effective, it would cost €350 billion to provide the country with enough cash to avoid borrowing from the bond market at the current punitively high interest rates.
This week, fund economists will be traveling to Spain to conduct their yearly assessment of the economy. If matters on the ground do not improve soon, the visit could well be the last checkup before the final operation begins.