The problems in Spain cannot be denied any longer. In fact, the crisis that hit the Eurozone is something that cannot be hidden.

Since the credit crisis that began in the U.S. a few years ago, countries and their banks have fallen like trees, showing black holes that had been hiding for years, as well as very bad practices that did nothing but make what was already a big problem worse.

Now that the complete rescue is about to come to Spain– the first one was only for the banks, although it counts as government debt– many authors and writers of Spanish newspapers question the competence of the European Central Bank (ECB), and wonder what prevents the ECB from saving us from total disaster by buying public debt of states that are worse off. In these writers’ speeches they explain that the ECB should act as the International Monetary Fund (IMF), and provide financial resources to those who need it.

Are they wrong asking for this? Absolutely. The answer to the question of why the ECB does not act as the IMF is this one: because they are not the same. Despite the fact that, apparently, both agencies have similarities, the truth is the objectives for which they were created are completely different in each one, and the way they respond is not the same. That is why it is advisable to make a couple of clarifications on the differences between the two entities, in order to understand why the ECB is not a “European IMF.” It was not intended to be one.

The IMF was created in a completely different context, when the consequences of the Great Depression could be still felt. Its creation reflected the attempt of several countries to avoid repeating the disastrous measures that weakened economic activity during those years.

Meanwhile, the ECB, successor to the European Monetary Institute, was created in 1998, but it did not make full use of its powers until the entry of the euro in 1999. The creation, established in the Maastricht Treaty, responded first to the oversight of the transition of member countries from their national currencies to the euro and, second,  the need for the existence of a bank for this currency.

With these completely different contexts it is logical that the objectives of both entities are not the same. Thus, the main function of the IMF is to oversee the smooth running of international economic policy, and to encourage it, acting as a fund where countries can ask for help when they need temporary financing.

However, the main objective of the ECB is to maintain the price stability in the euro area by maintaining the inflation at low levels, leaving other objectives subordinates to this first and foremost. Broadly speaking, it seems that we can define the IMF as a fund that lends money to countries who need it, and the ECB as that one who ensures the proper functioning of the Eurozone. So, the role of the first one is active, while the second one’s role is rather passive.

Now the big question is: if the euro is not working properly and there is a risk of its disappearance, can the ECB not protect it through the purchase of public debt? The answer is, again, no. Why? Because of the statutes which regulate it.

Since it was created, the ECB defined itself as completely independent from the member countries of the Eurozone– which has been questioned in recent years, especially by the suspect origin of the last directors of the ECB– and the measures should not respond to the national interests of any country. In the same way, the European institutions and national governments are required to respect this independence, and this means that there is no mechanism by which a member state may compel the ECB to act in one way or another.

This is the main reason why the ECB cannot rescue any Eurozone country. Besides this, there is another powerful reason that we forget sometimes: the conditions for being a member of the Eurozone are strict. It is not enough to wish to adopt the currency, there are steps to follow before completing the transition.

The ECB is responsible for safeguarding the proper functioning of the euro because it assumes that other institutions– created for that purpose– have been responsible for verifying that the candidates have the specific requirements for entry. If someone has not, whose fault is it then?

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New York, U.S.A. — Amid continued economic, financial, and political turmoil, several E.U. countries are seeing improvement in a crucial measure of competitiveness. According to a new Executive Action Report from The Conference Board, the cost of labor per unit of output has fallen significantly in a number of the hardest-hit economies, led by Ireland and Eastern Europe.

For the Euro Area, controlling unit labor cost (ULC) — defined as nominal labor compensation per unit of real output —may be key to redressing the competitive unbalance between core and periphery that has haunted a continent and fueled four years of recurring crisis.

“A drop in unit labor cost is an important sign of the beginning of adjustments in Europe’s most trouble economies,” said Bart van Ark, The Conference Board Chief Economist and co-author of the report. “For now it is mainly the reduction in wages which leads the adjustments, but once productivity begins to increase as well, it could be the key to a more sustainable recovery.”

Since states within the Euro Area cannot devalue their currencies or dictate interest rates, boosting ULC and, thus, competitiveness relative to other members of the zone can only come about through real changes in worker efficiency,” he adds.

There are early signs that the rebalancing through unit labor cost adjustments is under way. While France, Germany, Austria, and other relatively strong continental economies have pursued social welfare policies to limit unemployment during the downturn — thereby reducing productivity and increasing unit labor costs — countries with more flexible labor markets in the “Anglo-Saxon” model have been able to make faster adjustments.

Ireland lowered its ULC by 5.3 percent between 2008 and 2011, a success only rivaled by less mature Eastern European countries such as Hungary, Latvia, and Lithuania, which still retain their own currencies. Elsewhere outside the Euro Area, ULC in the U.K. has fallen by 3.6 percent — the sharpest decline of any large economy.

In the most troubled European economies of Greece, Portugal, and Italy, a tradition of rigid labor markets kept unit labor costs rising through the early years of the crisis. Continued weakness and deepening austerity measures, however, have recently pushed them towards turning points suggesting a strong reduction in costs and faster efficiency gains compared to the Euro Area’s northern core.

In Greece, ULC rose by 4.4 percent overall between 2008 and 2011, but fell by more than 5 percent from 2010 to 2011. With its large contingent of flexible part-time workers, Spain is further along; Spanish ULC fell 4.4 percent between 2008 and 2011. Across the Euro Area, unit labor costs in manufacturing have fallen by 3.9 percent in the past two years, after rising at the outset of the crisis.

Because of the rapid shifts in unit labor cost in recent years, the German manufacturing sector has become less competitive in terms of cost per unit of output relative to the manufacturing in many other European economies — again, led by Ireland, Eastern Europe, and the United Kingdom. Dramatic reductions in workforce and compensation have propelled British firms ahead of formerly more cost-competitive French, German, and Italian rivals. Meanwhile, Ireland is now Europe’s most efficient manufacturing economy by far, ahead of even low-wage off-shoring destinations like Poland.

In contrast to manufacturing, the service sector — which is more labor-intensive with output largely composed of non-tradables — remains a weak performer across Europe. Only Spain and the United Kingdom have managed to substantially lower unit labor costs in the services sector. With output falling faster than workforce or wages can be cut, Germany, France, Greece, and Ireland all saw significant ULC increases in services. The remarkable 41.5 percent decline in Irish ULC for manufacturing was largely offset by a 26.4 percent ULC increase in services.

Given the significant private and public sacrifices needed to bring down unit labor costs against an over-strong currency, an exit from the Euro Area altogether has become a tempting option for the most troubled economies. To test the consequences of a Euro Area exit, The Conference Board modeled the impact that regaining a national currency — and independent monetary policy — would have on unit labor costs in a country like Greece compared with alternative scenarios.

“The huge devaluation following an exit from the Euro Area would certainly boost competitiveness in the first year or two,” said Bert Colijn, labor market economist for The Conference Board Europe and co-author of the report. “But these effects would quickly evaporate, as the subsequent recovery in labor compensation in the medium- to long-term outpaces GDP growth. Hollowing out labor costs can only do so much. Lasting competitiveness gains must ultimately come from the productivity side of the unit cost labor equation.”

“For this reason, we found that neither a troubled economy nor the Euro Area as a whole is likely to benefit in the long run from a unilateral exit, or a wider breakup, or the status quo of muddling through,” says Colijn. “Ultimately, the best outcome for competitiveness is achieved with greater fiscal integration, including a banking union and Eurobonds, that will encourage the sort of investment needed for productivity, innovation, and competitiveness that is substantive and sustainable.”

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In recent weeks Spain’s banking crisis has gone from bad to worse. Spain’s credit rating has recently been downgraded from an A to BBB+ by Standard & Poor’s because of the debt it will most likely take on from its banks and regional government failures. Spain is the fifth largest economy in the Eurozone, leaving many worrying about the ramifications of these recent developments on the rest of Europe.

Currently Spain’s deficit is too high for the Eurozone. The European Commission says that Spain can be given more time to reduce their deficit from the 8.9% of the GDP – as it stands currently – by 2013. However, the high deficit in Spain is causing fewer individuals and countries to risk investing in the country.

Bond yields in Spain are up to 6.7% meaning that they are high risk. Yields on bonds are higher when they are riskier because investors want a higher return if they are putting money into something that is unstable. In contrast the German and US bond yield is at 1.28% and 1.64% respectively. Therefore, instead of investing in Spain’s government bonds more people are investing in the US and Germany. However, this high bond yield also means that Spain will accumulate more debt and have to pay a higher interest when borrowing money.

Despite all recent efforts the Spanish economy is expected to shrink 1.8% this year alone and another 0.3% next year. However, Prime Minister Mariano Rajoy insists that Spain will not require a bailout like Portugal, the Republic of Ireland, and Greece have needed; Spanish banks, on the other hand, have already asked for bailout money.

Bankia, a recently formed banking group of seven banks, asked for a 19 billion Euro bailout. Bankia originally reported a 309 million Euro profit for the year of 2011 when it actually had lost 2.98 billion euros. It is unknown as of yet how Spain will get the bailout money when it is already struggling under its own deficit.

The President of the European Commission, José Manuel Barroso, has suggested that they use the Eurozone’s new 500 billion euro stability mechanism to inject some capital into the banks, but Germany, Europe’s largest economy, has already rejected the plan. Another option is for Spain to give Bankia government bonds to then trade with the European Central Bank (ECB) for money.

Although it has been reported that the ECB has already rejected this plan a recent article by the BBC claims that these reports are false and that the solution is not yet off the table. The European Commission has also suggested creating a “banking union” to monitor all Eurozone banks in the future.

In addition to struggling with the mounting bank debts, Spain is also forced to rescue several regional governments who are no longer capable of borrowing money. Several regional governments have gone bankrupt and rating agencies, such as Standard & Poor’s, have put these regions at junk status. Most recently Catalonia, the wealthiest autonomous region in Spain, has asked for help from the central government; Catalonia accounts for one-fifth of the Spanish economy.

Spain is giving these regions government-backed bonds which they can then use to borrow money. However, as stated previously, these bonds are at a high yield which makes this solution temporary. A Spanish economy ministry spokesperson stated, “the goal is to reduce the pressure on the regions, which is often greater than the pressure on the state in general, with some regions not ale to borrow on the market.”

Regional banks have tried to strengthen each other through mergers. Ibercaja, Liberbank, and Caja3 merged in late May to become more resilient. This merger created the seventh biggest lender in Spain with 120 billion euros in assets. Liberbank and Caja3 were previously mergers of four and three regional banks respectively.

Spain’s unemployment as of April is at 24.3%, the worst in the Eurozone – even worse than Greece. It is expected to climb to 25.1% by 2013 even with the recent precautions taken by the newly elected center-right government. Prime Minister Rajoy has made several labor market cuts including cutting back on severance pay and restricting inflation-linked increases in salary; these decisions have been unpopular with unions and workers. Spain’s high unemployment also means that there are fewer people who are paying higher tax rates or even paying taxes.

Spain’s economy is heavily tied to the economy of Italy, the fourth largest economy in Europe. These close ties lead investors to worry that if there is a run on the Spanish banks there will also be a run on the Italian banks, throwing both countries into a deeper crisis. Italy is now borrowing at a rate over 5.66%; borrowing at a consistent 7% rate is considered unstable and has triggered the bailouts for Greece, Portugal, and the Republic of Ireland in the past.

The Spanish debt crisis was not caused by irresponsible government spending such as in Greece. Spain ran a balanced budget every year until the recession hit in 2008. The problems were planted when Spain joined the euro in 1999 and interest rates fell because Spain’s economy was good and other economies, such as the German economy, were not.

Investors wanted to invest in Spain which is what drove the interest rates lower. While the Spanish government resisted taking out more loans because of the cheaper interest rate the Spanish people did not. The country experienced a long housing boom that also affected the construction sector. When the recession hit, the housing and credit bubbles burst leaving many banks with toxic debt – debt that was unlikely to be repaid.

Image Courtesy of  Alberto Carrasco Casado

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From the year 2007 to 2011, the global economic system as a whole learned some of its toughest lessons and faced the hardest of times since the great depression of the 1930s. All of this started with irregularities in the US housing market and following credit crunch; then came the demise of Lehman and the chaos in the financial markets which triggered the global downfall in the growth rate, literally acting as fuel for a global recession.

This crisis was transported through various channels across the globe, creating a situation very close to the great depression where the pace of growth actually faded dramatically, where trade stumbled, financial markets dried out, and of course global unemployment bloomed.

A conceptual analysis of the empirical evidence from the period between 2007 to 2011 presents two broad cases of distinction. In the first case we were struggling to put the US economy back on track with the help of financial bailouts to corporations and financial institutions. In the second case we found that international institutions are providing a series of bailouts, creating a firewall against default by some countries in the Eurozone.

Death by Debt

Rapid, large scale accumulation of public debt poses a repugnant and most grievous threat to a national economy because it paralyses the eligibility of a country to secure any assistance in the future by the international community. It is nothing but financial death for a nation because it kills the natural basis of the financial system. The banking industry may collapse, lowering the value of domestic currency, causing irreparable damage to banks invested in the sovereign debt of the defaulting nation and worsening the potential global credit crunch.

Today economies, markets, and institutions are so interconnected and interwoven that any event or activity that can trigger a potential negative extreme, will have a direct and strong impact on other economies. For example, a drastic increase in public spending in China will probably increase demand for natural resources in Australia — and many more sophisticated illustrations can be easily found.

Bailouts and Future

How far can we really rely on bailouts? It all depends on how much we are prepared to mend the gaps between revenues and expenditure in government finances. In simple words, bailouts provided to any country does not mean that fiscal disparities are eliminated. In fact, bailouts often only act as the respirator of an ailing economy at its death bed.

In the case of the Eurozone debt, with the complications and assistance extended by the International Monetary Fund (IMF), it is a matter of diplomatic dynamics and not a real resolution that can be relied upon in the future.

IMF and other global economic and financial intuitions should draft a policy recommendation that virtually limits any reliance or mere assurance of a bailout by other nations in the future.

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Amsterdam, Netherlands - Atradius, one of the leading global credit insurance companies anticipates an increase in insolvencies across most developed markets. The Eurozone led slowdown in global growth and the tight financing conditions make it more difficult for businesses to grow.

Uncertainty over the Eurozone sovereign debt crisis and development of the economy has increased tensions in financial markets, though the latter have eased since the ECB intervention of Euro 1 trillion.

A major issue is that credit conditions in advanced markets have been tight and have shown hardly any improvement since the financial crisis in 2008. The banking sector continues to consolidate its debts and seeks additional capital to comply with new and stricter regulations. This has created a challenging environment for households and firms, especially in the Eurozone, and, to a lesser extent, in the US.

Insolvencies rise

Atradius expects the number of insolvencies to increase across most European markets as those of the US improve, as discussed in the April 2012 Atradius Economic Outlook [http://global.atradius.com/creditmanagementknowledge/publications/economic-research.html].

Increases are expected to be the highest in Southern Europe, with forecasts of double-digit growth in Italy and Greece. The insolvency situation is expected to deteriorate somewhat, even in Germany, despite its relatively benign economic conditions. Better news is coming from the United States. With the country’s moderate growth, Atradius projects a decrease in insolvencies. But the forecasted number of insolvencies over the year remains high from an historical perspective.

Downside risks

In general, insolvencies tend to track the business cycle, with economic growth below trend pushing up insolvency numbers. Therefore, there continue to be downside risks to this scenario.

Firstly, an escalation of the Eurozone crisis would hit firms and governments across the globe through financial and trade linkages. In accordance with our analysis in January, Atradius still expects the Eurozone to stay intact as the costs of a break-up would be extensive.

Secondly, the risk of a steep increase in the price of oil, as spare capacity is limited and unrest in the Middle East is high. While the dependence on oil is declining, a large price increase over a short period would increase retail prices and hurt consumer spending across the globe.

Atradius chief-economist John Lorie commented; “Whereas the US is moving on relatively well, in the Eurozone the sovereign debt crisis has moved from the financial markets to firms and households. As consumer confidence is low we see consumers unwilling to spend and banks unwilling to provide finance to firms in the Eurozone. Rates of insolvencies are likely to go up in those markets. In the US on the other hand, rates are likely to improve.”

About Atradius

The Atradius Group provides trade credit insurance, surety and collections services worldwide. With a presence through 160 offices in 45 countries, it has a market share of approximately 31% of the global trade credit insurance market. Atradius has access to credit information on 100 million companies worldwide and makes more than 20,000 trade credit limit decisions daily. Its products help protect companies throughout the world from payment risks associated with selling products and services on credit.

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FICO’s quarterly survey of bank risk professionals found growing concern for the stability of the student loan market and deepening fears about the nation’s housing sector. The survey, conducted for FICO by the Professional Risk Managers’ International Association (PRMIA), shows that bankers expect delinquencies on most types of consumer loans to rise, balances on credit cards to grow, and global economic forces to put increasing pressure on the U.S. economy.

Delinquencies on student loans causing concern

Student loan debt now exceeds credit card debt in the U.S., with experts estimating that $750 billion in student loans are outstanding. In FICO’s survey, 67 percent of respondents expected delinquencies on these loans to rise. That is 19 percentage points higher than last quarter. Only eight percent of respondents expected a decline in delinquencies.

“Evidence is mounting that student loans could be the next trouble spot for lenders,” said Dr. Andrew Jennings, chief analytics officer at FICO and head of FICO Labs. “A significant rise in defaults on student loans would impact lenders as well as taxpayers, who could be facing big losses due to these defaults. Our survey results underscore the ongoing challenges that millions of American households face as they try to cope with their debt during these uncertain times.”

Global concerns impacting U.S. economy

Survey respondents were also asked about global issues that could put pressure on the U.S. economic recovery. When asked about the most likely trigger for a possible double dip in the U.S. economy, the Eurozone debt crisis was cited most often (38.8 percent), just edging out U.S. government policies (38.4 percent). Another 19 percent are most concerned about the lack of spending and investment by U.S. companies.

Survey respondents were also asked about the economic growth of China as it relates to the future strength of U.S. consumers. Sixty-five percent of respondents felt that the global influence of Chinese consumers would overtake that of U.S. consumers within 5-10 years. By contrast, 28 percent felt that U.S. consumers would continue to wield more influence for another 20 years or longer.

“Whether it’s debt trouble in Europe or economic growth in Asia, there are significant implications for the near-term and long-term strength and health of the U.S. economy,” said Jennings. “There are risks, challenges and opportunities all around us. To compete in this increasingly complex global environment, we’re seeing more U.S. companies embrace innovative analytic technologies to help them understand and navigate the global playing field.”

Consumer credit seen weakening, led by housing concerns

Regarding mortgages, 47 percent of respondents expected mortgage delinquencies to rise and 13 percent expected delinquencies to decrease. That is slightly more pessimistic than last quarter. When asked about credit cards, 45 percent expected delinquencies to rise while 21 percent expected a decline.

That is also more pessimistic than last quarter and another sign of deteriorating confidence among bankers. In addition, 54 percent of respondents expected credit card balances to increase. These expected increases are likely due to higher spending by some consumers and financial stress for other consumers who are unable to pay down their balances.

Auto lending had a fairly balanced outlook with 33 percent of respondents expecting an increase in delinquencies, 22 percent expecting a decrease, and 45 percent expecting no change in the level of delinquencies.

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