Spain Gets its Bailout and the Market Goes Down

by Marilou Long on June 12, 2012

in Banks,Credit Crisis,Debt,Foreign Markets

Over the weekend, EU members agreed to fund a 100 billion euro bailout of the Spanish banking system.  After an initial positive response, European markets all traded off, and US markets also ended on a negative note.  Today’s Morning Briefing from Ed Yardeni has a good explanation for the lack of response to the news:

“Debt-financed bailouts are no longer fashionable in European bond markets. There is something fundamentally wrong with the notion that a debt-challenged government that has been financed by shaky banks can rescue them by borrowing more money to do so. That’s especially true if the government’s outstanding debt is subordinated to the new debt, as the terms of the loan to Spain seem to suggest. That’s almost a sure way to get shut out of the bond market, making it tougher to raise new money and to refinance outstanding government debt. Ironically, European leaders thought that by providing Spain with more money than is currently needed to shore up its banks, they would impress the markets and buy more time. Apparently, they did not.”

We’ve written before about the problem with creating a monetary union without a fiscal union, and there may be some signs that Europe is working towards some kind of banking and fiscal union.  The Economist has an interesting article about this today.  There is an increasing sense that a banking union is needed to deal with these ongoing issues of bad debt in the banking system.  I think that a banking union would be an easier step to accomplish than a true fiscal union, so this could be a positive step for Europe.  From the linked article:

“The growing number of capital calls across banks on Europe’s periphery is leading to a freeze in funding markets, as investors fret that banks may be hiding big losses and as banks lose trust in one another. “The interbank market is totally closed,” says the boss of one large European bank, adding that he is keeping excess cash at the European Central Bank (ECB) rather than lending it to other banks.

It is also causing jitters in government-bond markets as risk-averse institutional investors such as pension funds and insurers worry that governments in the periphery may be swamped by mounting losses in their banking systems. Money is flooding into the safest option, Germany, where the government borrowed five-year money at just 0.41% on June 6th. Despite these signs of panic, the ECB left rates on hold at its June meeting.

The crisis is intensifying calls for the establishment of some sort of banking union, with centralised powers and funding to regulate and supervise banks as well as to recapitalise ailing ones and to insure retail deposits. On June 6th the European Commission took the first steps towards this with a proposed framework for dealing with failing banks that includes plans for sharing some of the costs of recapitalising cross-border banks.”

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