Eye of the hurricane

Ever since Spain was offered EU support for its banks, the country has been in the eye of the proverbial hurricane. In the short term, an eerie silence has settled in, but on the horizon the next storm clouds are gathering.

Everyone knows the chaos, against which there is no protection, will soon return. And this is how it may happen to the Spaniards. That's because the 100 billion euros from the European Union that Spanish banks can hope for had eased the situation somewhat earlier this week. But meanwhile, the scenario has darkened. Financial experts are expressing louder doubts that the proposed aid package for the ailing banking sector is sufficient to put the country back on its feet economically.

Stefan Schneider, head of the macroeconomics team at DB Research, a think tank belonging to Deutsche Bank, put a damper on the hope that recapitalized banks would issue loans for needed investment. Credit requires demand, he said: "It is a phenomenon of the crisis in Spain that the private sector, companies and households, are together very highly indebted, more than 200 percent of gross domestic product. The willingness to take out new loans therefore is very limited for the foreseeable future," he said in an interview with DW. For this reason, it is currently unlikely that the Spanish economy will quickly gain momentum again through massive lending, he said.

Almost down to junk level

Spain, along with Greece, Europe's biggest problem child is once again in the markets' crosshairs. On Thursday, yields on ten-year government bonds exceeded the critical 7 percent mark for the first time since the introduction of the euro. Interest rates of 7 percent in the euro area have long been considered unacceptable, because no state can afford such expensive credit in the long run. Greece, Portugal and Ireland each applied for bailout funds soon after this level was reached.

The International Monetary Fund has warned about further vulnerabilities in the banking system. In an announcement in Washington on Friday marking the conclusion of a review of the Spanish economic and financial system, the IMF said that while the biggest banks could pass a stress test, there were still some risks and vulnerabilities in the financial system as a whole.

How tricky the situation is for the Spanish government and the EU has been demonstrated by the massive downgrading of Spain's creditworthiness. The rating agency Moody's recently unsettled investors again by downgrading the country three notches - leaving it just above the level of junk bond status. Moody's justification was based on the proposed bank bailout, which would only further increase the country's indebtedness. Paradoxically, this was precisely the measure that was supposed to help.

A nightmare for proud Spaniards

What if Spain has more financial problems and cannot pay its bills? For example, for unemployment insurance, on which a good quarter of the working age population is dependent. Then, like Greece, Portugal and Ireland, the country would be entirely at the mercy of the European bailout fund. That is something the government in Madrid vehemently opposes. It fears EU controls associated with the partial loss of state sovereignty and independence. For the proud Spaniards, this would be a nightmare. Hence, the constant attempts by Prime Minister Mariano Rajoy to play down and to explain the possible bank assistance.

In reality the situation is more dramatic than the pronouncements from Madrid would have us believe. Necessity has driven Rajoy to write a letter to EU leaders requesting a support program from the independent European Central Bank. The EU increasingly also has a lot of explaining to do. While it could sell help to Greece, Ireland and Portugal as a means for dealing with relatively straightforward problems, Spain is the first big eurozone country threatened with collapse, and the bailout fund is in danger of being overstretched.
A lack of solidarity in Europe?

Of course, scenarios can be developed in which the bailout fund, with its volume of around 750 billion euros, eventually reaches its limit, Schneider said. "But instead we should probably ask: Are the donor countries, who are becoming fewer in number with every country that uses the bailout fund, accordingly less willing to finance the budget deficits of the crisis countries over several years?" For smaller countries like Greece or Portugal, this can perhaps be arranged, he said. "But if you look at the sums that would be required if countries such as Spain or Italy had to be bailed out, then I think it would be very difficult for the politicians in donor countries to convince the public of the need for assistance."

In order to pay the debts of southern euro states Germany in particular would have to dig deep into its pockets, Schneider said. At a recent event in Washington World Bank President Robert Zoellick even spoke of Germany's mission to lead Europe out of the crisis. "History has given Germany a role that isn't easy," Zoellick said. It had no other choice but to use its weight as Europe's leading economic power, he said.

Sound and fury

Zoellick's paean to the economic power of Germany will not have caused Chancellor Angela Merkel to cheer because of the implicit payment request. "Even Germany's powers are not unlimited," Merkel warned in a policy statement to parliament prior to the G-20 summit in Mexico. All packages to tackle the crisis agreed to so far would be "sound and fury," if it turned out that they would overwhelm Germany's abilities. The Chancellor explicitly criticized the "simplistic communitarian solutions" in Europe and once again rejected eurobonds, or any joint debt repayment fund.

The ultimate proof

Schneider shares Merkel's view: "The fact that everyone says Germany must open its wallet is really too great a burden." In the final analysis, Europe must decide whether, national sovereignty will be given to Brussels in exchange for support from donor countries, he said. "And on this topic - keyword Spain - there is still no conclusive evidence that these countries are really ready to do this." This is the dilemma that European policymakers will have to confront at the next EU summit, he said.

Author: Ralf Bosen / sgb
Editor: Gregg Benzow