Risk of intervention

The Spanish economy is in a state of emergency, or, if you prefer, at risk of being intervened. The risk premium hit 540 basis points on Wednesday (levels that sparked the need for bailouts for Greece, Ireland and Portugal) and Bankia’s shares continue to plummet as befits a bank that appears adrift. There are many causes behind this emergency, such as Europe’s inability to resolve the Greek crisis, political interference in the management of Caja Madrid and the failings of the Bank of Spain in detecting the holes in Bankia’s books. But what best explains the suffocating lack of confidence of investors in Spain is the inability of the current government to manage the crisis at Bankia and sort out the regions’ deficit.

But with the yield spread above 500 basis points, what one cannot do is to appear before the public to say that Bankia will be nationalized without knowing how this will be funded, as was the gist of Prime Minister Mariano Rajoy’s discourse last Monday. Neither is it appropriate to deny the fact and lay the blame for Spain’s woes on the situation in Greece, nor to insist that Spain will not need a bailout from Europe, nor to snub the offers of a pact proposed by the main opposition party. Quite the contrary; this is a moment to ask for help from Europe and the opposition.

If more than a week after the nationalization of Bankia, we still don’t know how this will be carried out, what we have in hand is a case of serious incompetence. All this posturing and the decisions that have been taken, combined with the gratuitous cannibalization of the country’s institutions (the regions, the Bank of Spain, the justice system and supervisors have been subjected to public ridicule) pave the way for an intervention not only of the banks, but the economy itself.

Happily for the government and for Spaniards, the European Commission on Wednesday proposed extending the deadline for bringing the deficit down to three percent of GDP by a year to 2014. The Spanish government should have been negotiating this option with Brussels from the start rather than stubbornly insisting unilaterally in reducing the deficit target for 2012, because this would have allowed the government to mark the pace of the cutbacks required and accommodate a more measured budget policy.

Dubious measures

The conditions accompanying the extension in the timetable for hitting the deficit target appear to indicate that Brussels has got tired of the government’s mishandling of the situation. As if the situation in Greece were not enough, this has put the stability of the euro further at risk, leading the EC to move to a phase of imposing recommendations.

Two of these (putting the financial and labor reforms in motion) highlight the dubious quality of the measures introduced by the government, while others reveal a deep lack of confidence in the public accounts (establishing an independent body to oversee fiscal policy and the imposition of additional adjustments on the regions).

Another one amounts to a course for economic policy that Rajoy has been unable to articulate; namely, raising VAT and using the subsequent increase in revenues to allow for a cut in personal income tax. A proper internal devaluation.

The draft recommendations, which will probably be accompanied by moves by the ECB to lower the risk premium, appear to be strict control of the Spanish economy. The reality, as Rajoy knows well, is that Bankia needs an injection of European public funding; a direct recapitalization of the bank by the European Stability Mechanism, in order not to increase Spain’s public debt. Spain should negotiate a change in the regulations that allows such direct recapitalization. It was a crass political error, under the illusion of projecting sovereignty, to plot a bailout for Bankia without informing the European Commission and the ECB beforehand. Errors of this ilk, one after the other and unacknowledged, are what have put Spain on the path of effective intervention.