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Billions pledged to save Spain's banks

Europe tosses €100-billion lifeline to Spanish banks, but looming Greek election poses deeper risks

00:00 EDT Monday, June 11, 2012

ROME -- After more than two years of denials, waffling and half measures - it's crunch time for Europe.

The fringe countries in the 17-member euro zone have been unravelling at an alarming rate in recent weeks and the situation could easily reach a truly genuine crisis on Sunday, when Greece holds its second election since the inconclusive May 7 poll. If the surging anti-bailout parties win, Greece's exodus from the euro zone would go from possible to probable.

Europe's debt crisis took a turn for the worse Saturday, as Spain asked its neighbours for as much as €100-billion ($129-billion) in loans to keep its banks from failing, becoming the fourth country on the list of bailed-out euro countries as the region grinds though a period of crushing debts and economic stagnation.

Spanish Prime Minister Mariano Rajoy said economic conditions and the unemployment rate will deteriorate further this year. Markets will also be watching France's parliamentary elections Sunday for signs Socialist President François Hollande has enough support to enact an agenda emphasizing government spending over austerity.

Mandated government spending cuts in exchange for emergency bailouts have been the preferred mode in Europe's economic crisis, spurring widespread protests, and in Greece's case, forcing two elections.

In Sunday's Greek vote, a victory by parties opposed to the bailouts and austerity would force euro zone leaders "to determine in the very short term just how far it is prepared to go to keep Greece in the euro," said Robert Wessel, managing partner in Toronto with Hamilton Capital Partners.

Until Greece's May election, many investors, business chiefs, investors and politicians thought that Greece, were it to leave the euro zone, would do so several years down the road, after all possible options were exhausted.

But that was before 70 per cent of voters endorsed parties that want to shred the austerity programs, which they blame for plunging Greece into deep recession, or ditch the euro currency, or both.

If those parties form the next government and try to gut the austerity programs, the programs' sponsors - the European Union, the International Monetary Fund and the European Central Bank - could very well yank their financial support, almost certainly triggering Greece's quick and chaotic exodus from region. That's because the rescue loans were delivered in exchange for strict austerity and economic reform commitments.

Depending on who wins, the Greek election on Sunday could hit the euro zone like a nuclear bomb after a couple of months of relative peace in the wake of Greece's second bailout, in February.

Since Greece's May election, the region has lurched from one crisis to another, rattling the markets as the prospect of the euro's potential demise gained momentum.

The sovereign borrowing costs of Italy and Spain, the region's third and fourth largest economies, soared as investors dumped those countries' bonds in favour of the safe bonds of Germany, Britain, the United States and Canada.

The rapidly spreading banking crisis came to head on Saturday, when the Spanish government confirmed the worst-kept secret on the continent - that many of its banks, stuffed with dud real estate loans, were in dire need of emergency capital - and sought as much as €100-billion in financial assistance from European rescue funds.

On Sunday, Spain's centre-right prime minister, Mariano Rajoy, declared the bank bailout a victory for the Spanish banking system and for the euro itself. "The euro is an irreversible project," he said on television.

Others weren't so sure. Only a day before the official announcement of the Spanish banking bailout, Italian Prime Minister Mario Monti, speaking at a conference in Venice, said: "There is permanent risk of contagion, contagion from Greece, from other countries."

The question is whether the Spanish bailout marked a turning point for Europe's nearly three-year-old debt, growth and banking crisis, or was just another bandage effort that will ultimately fail to stop the hemorrhaging.

Some economists and strategists think the slow-motion bank runs in southern Europe could turn into full-blown bank runs capable of instantly crushing economies.

The bank bailout does not mean that Spain itself is cured. The effects of the busted housing boom are still rippling through the economy, raising the jobless rate, destroying businesses and damaging banks. Mr. Rajoy on Sunday said the unemployment rate - now 24 per cent - will continue to rise. "This year is going to be a bad one," he said.

Economists fear that Spain, which is firmly back in recession, is too big to save if continued economic and financial deterioration were to shut it out of the debt markets.

But Greece is the immediate worry.

If the anti-bailout parties win the Sunday election, form a coalition government and scrap the austerity programs, financial assistance probably would be withdrawn.

Then all bets about Greece's membership in the euro zone would be off.

*****

BAILOUT IN BRIEF

The loan, worth up to €100-billion ($129-billion) is to be channelled through Spain's state bank-rescue fund, known as FROB, and then extended to banks that need it.

Interest rate on the loan to be 3 per cent, El Pais reported on June 10

€100-billion is equivalent to about 10 per cent of Spain's GDP

Spanish banks have €184-billion ($237-billion) of what the Bank of Spain terms "problematic" assets linked to real estate

Source: Bloomberg

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