Spain's borrowing costs have only risen since the European Union announced a €100 billion bailout of the country's banks ten days ago. On Monday the yield on Spanish 10-year bonds closed above 7% for the first time in the euro era. That's compared to a yield of less than 6% on 10-years before Spain was "rescued."
By Tuesday, the market's neuralgic reaction to the Spanish bailout prompted Prime Minister Mariano Rajoy to plead once again for a different approach. At the G-20 summit in Mexico he argued that everyone would be better off if the EU's bailout funds recapitalized Spain's banks directly. This, Mr. Rajoy argued, would "break the link between risk in the banking sector and the sovereign risk."
In other words, the way to solve Spain's problems, Mr. Rajoy believes, is for someone else to carry the debt incurred by borrowing €100 billion or so to bail out Spain's banks. Then the cost and risk of the bailout would wind up on someone else's balance sheet. Spanish yields would start to fall again, and Spain would avoid a full-blown bailout. Spain made this argument before the bank-bailout loan was announced, but Germany demurred, insisting that the risks of taking on Spain's banks should fall on the Spanish.
Spanish Prime Minister Mariano Rajoy.
Mr. Rajoy's proposal would be a great deal—for Spain. But it's far from clear why Spain's euro-zone neighbors should bear the cost of rescuing its banks, or even how that might work. Restructuring Spain's problem banks means making distinctions between banks that can be saved, banks that shouldn't be saved, and banks that don't need saving. If public money does go into any particular institution, that should ideally be done in a way that minimizes the cost to taxpayers—for example, by imposing losses where possible on private owners and creditors first.
But neither the European Financial Stability Facility nor the European Stability Mechanism—the EU's bailout vehicles—are in any position to make those judgments. Among other problems, their involvement creates a third-party payer issue that avoids the hard choices (and raises the overall costs of the bailout) because someone else is spending the money.
Even then, a bailout is not any bank's inherent right. If a bailout happens at all, one hopes it's only because its long-term costs to the economy and taxpayers don't exceed the collateral damage of letting a particular institution fail. Then again, if bailing out the banks is going to drive an entire country into bankruptcy, as it did in Ireland, then the right course is probably not bailing them out at all.
Mr. Rajoy is right that the banks' debts and his country's solvency have become intertwined. But at least some of the bad debt is the result of politically directed lending during the boom times. What's more, Spanish banks owned 29% of Spain's sovereign debt as of March, up from 12% in 2010. That sort of "link" was presumably fine with Madrid when it was financing its deficits these past two years.
Now, however, that government debt is in danger of becoming yet another bad loan for the banking system. No wonder Germany wants to keep these entanglements at arm's length
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