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Spain has received a 100 billion euro ($125 billion) after denying it needed it for several weeks. Although the announcement of the bailout originally had the global markets opening high, the uncertainty surrounding the details and implications of this bailout have caused the enthusiasm to disappear. Investors are still worried about spending money on Spain and they are also worried about what this bailout means for Italy.
The rating agency, Fitch downgraded Santander and BBVA – two of Spain’s largest banks – from As to BBB+s. This downgrade, in addition to uncertainty in the markets has caused investors to sit on their money rather than risk spending it. Fitch claimed the lower rating was caused by its worries that Spain will “remain in recession through the remainder of this year and 2013 compared to the previous expectation that the economy would benefit from a mild recovery in 2013 which directly affects the banks’ volumes of activities in Spain.”
The exact amount of emergency funds for Spain are still unknown, but the amount will be announced later in June after the Spanish banks have been audited. Many Spaniards were surprised about the bailout after their government insisted it did not need the money. There were several demonstrations on June 10 against the bailout after the announcement was made.
The Spanish government insists that the banks are the ones that need the bailout and are receiving the bailout, not the government itself. However, the bailout money cannot go directly to the banks, as Spain wants it to be, and must go through the Spanish government. A troika will also be created to oversee the financial management of the money in Spain just like in the bailouts for the Republic of Ireland, Greece and Portugal.
The bailout was meant to alleviate the concerns within financial markets that Spain itself was unstable and would go down with its banks. According to Richard Hunter of Hargreaves Lansdown stockbrokers, “some much-needed time has now been bought in Spain, which will allow the market an – at least temporary – sigh of relief.” However, the bailout seems to be its own worst enemy. The uncertainty surrounding the exact amount, the outcome and the mechanism of the bailout have not led to more investing.
Most of the bailout funds will come from the newly founded European Stability Mechanism that was formed specifically to help alleviate the Eurozone crisis. The funds are considered a loan that the Spanish government will eventually have to pay back, meaning this bailout makes Spain even more in debt. However, the fund itself will be considered a “senior” creditor which means that it will be paid back first if Spain defaults on its loan. Many investors are worried that they will not get paid back if they invest in Spain by buying its government bonds because everyone would be second to the Mechanism fund. Therefore, the Spanish bonds that were over 6% previous to the bailout are now almost up to 6.5% after the bailout according to the BBC.
Spain was still unsure about receiving a bailout but European finance officials pushed Spain into receiving help for its banks.
Moody’s rating agency has also said that Spain’s banking problem, “is not likely to be a major source of contagion to other euro area countries, except for Italy.”
Many are now worried that if Spain’s bailout does not succeed, Italy may be next to need help – if it’s not already too late. Italian bonds are up to 6%, meaning that investors see these bonds as high risk. The Italian GDP dropped 0.8% in the first quarter of this year whereas Spain’s only dropped 0.4%. Most predictions show the Italian economy shrinking at least another 1.5% this year. This is Italy’s fourth recession since 2001 and consumer spending and exports are down.
The Italian government has recently been practicing austerity measures under the government of Prime Minister Mario Monti. The Italian Economic Development Minister, Corrado Passera stated, “this great discipline that we have imposed on ourselves in terms of public finances makes us one of the countries best equipped to confront the financial turbulence that Europe finds itself in today.” Passera also claimed, “in the past months, Italy has done, from a financial point of view, everything that needed doing to save itself.”
Italy currently relies heavily on funding from the European Central Bank, which could hurt it in the long run. However, Italian banks have not suffered as much as Spanish banks because they did not suffer from the same housing bubble. Italy’s unemployment rate is also half of Spain’s and its borrowing costs are lower. Italy’s deficit for this year is lower than Spain’s but its overall debt is higher. Still, Italy is in a fragile position.
Sovereign debt expert Nicholas Spiro has warned that too many are linking Spain’s problems to Italy. “Where Spain goes, there is the perception that Italy will follow, which is terrible because it is like comparing apples and pears.” Spiro claimed that Italy’s economy was “infinitely better” than Spain’s, particularly because Italy did not have to deal with the same housing crisis as Spain.
Although it looks as though Italy may save itself, investors are still too skittish. Currently many reforms are still necessary and will have to be passed over the next year. Prime Minister Monti had the support to push through these reforms but he seems to be quickly losing it.
Monti and newly elected French President Francois Hollande are both in favor of Eurobonds, bonds that are guaranteed by all of the Eurozone. These Eurobonds would help alleviate Italy’s debt and would mean its bonds would not be as high a risk to investors. Hollande and Monti will meet on June 14 to discuss the possibility of Eurobonds. However, Merkel has already announced that she is against them and Germany’s support will be necessary for Eurobonds to be successful at all.
Image Courtesy of European Council