EU Debt Crisis: Better or Worse?
The European debt crisis either got better, or it got worse today. Nobody really knows for sure.
After an emergency conference call this morning among eurozone finance ministers, Spain’s Luis de Guindos announced that Spain will seek a EU bailout. That makes Spain the 4th eurozone country to seek a bailout. Ireland, Portugal and Greece are the others.
The move was widely expected this weekend after the IMF released a 77-page report yesterday that basically says Spain’s baby banks are in deep, deep doo-doo.
Its a big deal because Spain is the world’s 12th largest economy. If it goes down the tubes then so goes the rest of the EU. It is one of those countries that… welll… are “to big to fail”.
Described in American terms, Spain is having a TARP moment.
The EU is scrambling to build a sovereign debt firewall. They need to be able to absorb the financial blows the eurozone will suffer in the event of a disorderly exit of Greece from the EU.
Greek elections next weekend will tip the scale one way or the other. Greece could default on its sovereign debt as early as the end of this month.
The EU is battening down the hatches preparing for the worst. Spain’s banks have been known to be in bad shape for some time. Just how bad nobody knew. Until a week or so ago Spain said they could weather the storm without a bailout. Spain commissioned an assessment of their banks, but that report is not expected back until after the Greek elections.
EU finance ministers felt they couldn’t wait that long. They felt compelled to deal with Spain’s banking crisis before the Greek vote in order to maintain investor confidence in other eurozone countries.
Ipso facto… today’s emergency conference call and quick decision.
What Deal Was Made?
In a hastily prepared statement, the eurogroup of ministers said it was prepared to lend up to €100 billion euros ($125 billion U.S.) to Spain. €40 billion is being kicked around as a starting point.
According to the statement:
The loan amount must cover estimated capital requirements with an additional safety margin
– Eurogroup Statement on Spain, 6/6/2012
The loan money will come from one or both of two places:
- The €420 billion euro European Financial Stability Facility (EFSF)
- The new €500 billion euro European Stability Mechanism (ESM)
Which one matters. First, according to the Financial Times, the EFSF does not have preferred seniority status. That means if Spain runs into trouble it doesn’t have to pay back the EFSF first. It does with the ESM.
The EU obviously would want the loans to be made through the ESM. The ESM is also the permanent solution for handling future capitalization problems. However, the ESM won’t be up and running until next month.
It is possible that small emergency EFSF loans will be made until the ESM is functional and the bulk can come from it later. The EU hasn’t decided what to do with the EFSF after the ESM comes online.
Through Spain’s FROB – the Fund for Orderly Bank Restructuring – Spain loans the money to recapitalize its own ill banks with few strings attached. Spain, not the banks, is held accountable for repayment of the loans. That is an important requirement Germany’s Angela Merkel insisted on. Spain has to deal with their own failed banks.
Complicated, isn’t it? No wonder the EU is so screwed up!
Is the eurozone debt crisis better or worse as a result of today’s action? That remains to be seen.
Some in the us-against-them political world will gleefully hail today’s deal as a death blow to austerity in Europe. Some macroeconomists will say it is a step in the right direction, but not a big enough one.
€100 billion euros sounds like a lot of money, but it’s not. The national debt of the United States has been known to jump up nearly that much in a single day.
Spain could burn through that cash in a hurry and come back with hat in hand again soon. Then there is Italy. And then there is Greece or maybe Ireland or Portugal or maybe someone else.
For many months or years to come, there is more drama left in this saga than a daytime soap opera!