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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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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