Europe braces itself for bailout dilemma: who gets the money?

EU divided over whether Spanish government or just banks should receive funds

Luis Doncel

With each passing week tightening the pressure on Spain’s banking sector, more and more European Union officials are coming round to the idea that Spain will eventually need a bailout. “They have to stop throwing out figures. Where are you going to get the dozens of billions of euros to recapitalize the Spanish financial sector? The current market conditions make it impossible to obtain it there,” said one EU source.

On Sunday, Der Spiegel reported that German Finance Minister Wolfgang Schäuble has pressured his Spanish counterpart Luis de Guindos to take a Brussels rescue plan when they met in Berlin on Wednesday. According to the magazine, Angela Merkel’s government, which estimates that the Spanish banking sector will need between 50 billion and 90 billion euros, decided earlier last week to begin convincing Spain to take a rescue.

However, Spanish government sources maintain that the two ministers only spoke about EU banking policy and not an intervention. “Only Spain can say whether it needs a bailout or not — no one else,” said a German source. But Brussels is also aware of the destructive potential of a bailout and prefers that recapitalization be done through private investors or by issuing public debt. But because these options seem unfeasible at this time, the euro-institutions have intimated that there are funds and the necessary mechanisms to prevent a collapse in Spain’s banking system.

Mario Draghi, the European Central Bank (ECB) president, reiterated last week that his duty is not to “fill in the gap left open by the inaction of governments.” If the worst does finally happen, there remain doubts as to whether the EU rescue organizations will just address specific problems, including Bankia at the head of the list, or if the insolvency virus has infected the entire country, which will mean that Spain will end up receiving the injection of funds.

The bailout fund could be the seed of a common European banking union, but that takes time to build”

The more dramatic voices are saying that if the loans do go straight to the government, the country will be subjected to a full intervention with all its consequences — much in the same manner as Ireland, Greece and Portugal. This scenario doesn’t offer any positive reassurances. But if the money was just destined to the embattled financial entities, Spain would still retain some room in which to maneuver.

No one knows how much taxpayers will have to pay for the excesses of the building boom. A report released Thursday by Morgan Stanley estimates that the banking sector needs between 45 billion and 55 billion euros, although other analysts raised the figure to 100 billion. The exact amount will not be known until later this month when independent consultants Roland Berger and Oliver Wyman release their final analysis of the sector.

“The government and the regions this year have some funding needs — debt maturities, deficit and the injection of capital in Bankia — which amount to at least 250 billion euros. With the risk premium at around 540 points, it is impossible to issue debt for this amount. There is no choice but to seek outside help,” says Joaquín Maudos, professor at the University of Valencia.

One day before Economy Minister De Guindos admitted that the future of the euro will be played out in Spain and Italy in the coming weeks, European Commission President José Manuel Durão Barroso suggested changing the rules for the rescue fund by channeling resources into the banks and bypassing governments. But as the EC’s economic and monetary commissioner, Olli Rehn, pointed out, the current rules prevent this.

We need a European solution, but one that is based on transfers and not loans”

EU leaders, who will meet in Brussels on June 28-29, can agree to slightly slacken the noose that is tightening around Spain. “It seems difficult to change the rules quickly but throughout this crisis we have gotten used to making last-minute decisions that many thought were impossible,” says one EC source.

“Direct recapitalization is the best option. The bailout fund could be the seed of a common European banking union, although it does not have the necessary structure at this time. And that takes time to build,” says Andre Sapir, of the Bruegel Institute.

Prime Minister Mariano Rajoy has been firm — at least in front of the microphones — that Spain does not need any type of rescue. “The Apocalypse is not near. We will not tank,” he said on Saturday. A spokesman for the Economy Ministry says that a “direct injection is not a government initiative, and in any case it would also be valid for all European banks, not only for the Spanish entities.” But this type of initiative has its problems, the biggest being Angela Merkel. The German chancellor has made it clear that she rejects bailouts that do not go directly to the governments, which can be held accountable for the money they receive from Brussels.

During a week in which Spain dominated the front pages of the Financial Times and The Wall Street Journal, which even reported that the IMF has already prepared contingency plans to rescue the euro-zone’s fourth largest economy — a notion that was refuted by both the government and IMF officials — the trips taken by De Guindos to Berlin and Deputy Prime Minister Soraya Sáenz de Santamaría to Washington did not dispel the suspicions that something serious is about to occur. The possible departure of Greece from the euro zone merely complicates the situation.

But can Europe afford to allow an economy as important as Spain’s to cave in? “I think the correct question is not that, but whether Europe can continue with the uncertainty being generated by the problems in Spain’s banking sector. The most urgent move is to find a way to recapitalize the institutions, and, if there are no funds in the country, they will have to be tapped from abroad,” says Sapir.

A similar view is taken by Simon Tilford, chief economist at the think-tank London Centre for European Reform. “The ECB should ward off the risk of insolvency, but it is very unlikely it will. For this reason we need a European solution, but one that is based on transfers and not loans,” says Tilford. The EC is also pushing for a common front based on a unified Union banking policy, with a guarantee fund and the issuing of euro bonds. But it seems unlikely that these reforms will be worked through in time to save Spain.

An intervention would mean the door slamming shut on the Treasury’s access to credit markets, and the consequences of that could be devastating for the Spanish economy, which in the last quarter has seen an unprecedented degree of capital flight amounting to 97 billion euros.

In addition to being just another domino piece in the euro zone, the fall of Spain would also heighten other risks. The markets would then turn their focus on Italy, and later to France and Belgium. Some nations have demanded that if there is a bailout, it should be carried out now. “Some northern Europeans say that if there is the need for another bailout, it should be done as soon as possible to end this nightmare. They do not realize that this would lead to another situation; one that is a lot worse,” said a Commission official.

Cracks show in interbank system


When Spain was preparing to enter the euro zone, central bank economists began working out different scenarios about the problems the Spanish economy could face as part of the single-currency union.

At one meeting, the head of the studies division, José Luis Malo de Molina, concluded: “All of the problems can be weathered or fixed unless there are cracks in the interbank system.” He was right.

The interbank market has been closed for months, the flight of capital has hit a record high in Spain, customers are withdrawing their savings, and credit has been nationalized.

Last week, the media in Germany and Italy were reporting the restrictions imposed by German regulators on the Italian bank Unicredit to limit the money it can take from its branches in order to repatriate it to its head offices.

Austria has also limited the amount of funds banks can repatriate to branches in Eastern Europe, which is completely dependent on foreign credit. This type of practice is also being put in place on a de facto basis in many other areas to avoid capital flight.

An Italian Unicredit bank official visiting Madrid recently explained how this nationalization of credit has had its effects on his bank, which has 57 percent of its holding outside Italy.

“The best place to see the crack in the interbank market is in Tirol del Sur, a northwestern region of Italy that borders Austria. The branches there have to charge Italians higher interests than the Austrians, who often just live in the next town,” he said.

Analysts have called it the Balkanization of European banks. “Even if the euro zone survives, the unified financial market may not,” says one analyst.

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