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Spain – too big to fail, not too big to bail

2012 June 3
by Paul Vallely

The members of Spain’s national football team have been told that they are not to use Twitter for the next few weeks. The general assumption is that this is to do with the Euro 2012 competition. But it could, of course, be another desperate attempt by the Spanish authorities to take no risks with anything that might inflame the financial markets. Alvaro Arbeloa on austerity might prove just too provocative.

Spain is in its worst financial crisis for a century. The gallows-humour gagsters who brought you Grexit or Grout – to describe the possibility of a disorderly exit by Greece from the euro – have two more bits of japery on offer. Spanic is meant to encompass the markets’ alarm over Spain’s twin financial and economic crises. More portentously, Squit vulgarly raises the prospect of Spain quitting the euro too.

Why should we care? For two reasons. A Spanish exit would send ripples round the global economy which might build to a tsunami by the time they crashed upon our shores. And the process Madrid is currently undergoing – slashing fiercely to reduce a budget deficit amid a gathering recession – has lessons for Britain at a time when George Osborne, for all his Budget voltes-face, continues to insist there is no alternative to his Plan A.

Almost €100 billion has been pulled out of Spanish banks in the first three months of this year. That is around a tenth of the country’s GDP. Two-thirds of it went in March alone as Spanish citizens and foreigners rushed to find safer places for their money. This capital flight can only have accelerated since, as Spain has resisted pressure to seek international assistance for its parlously debt-stricken banks.

It is those banks which have provoked the latest crisis in the eurozone’s fourth biggest economy. The Spanish government has just had to find €19 billion to bail-out Bankia, the nation’s third biggest lender. Its story is all too familiar. Banks which the IMF pronounced “highly competitive, well-capitalised and profitable” before the 2008 crash – and which “would be able to absorb losses from large adverse shocks without systemic distress” – are now on the brink of collapse.

Echoing the US sub-prime mortgages debacle, Bankia made risky loans to low-income immigrants, and built the biggest portfolio of property loans in Spain. It was the same old combination of over-leveraged debt, poor regulatory supervision and a property bubble that burst. Reckless property developers took any loan on offer and arrogant bankers obliged. The man at the top, the infelicitously-named Rodrigo Rato, left the sinking Bankia ship last month just before it was nationalised.

All this is taking place against an economic policy background uncannily similar to that of Coaliton Britain. A budget deficit, which reached 8.9 per cent of GDP last year, is being brought down as fast as possible. The aim is to win the confidence of the markets and cut borrowing costs.

But as in Italy, Ireland and Portugal severe austerity measures seem only to be deepening recession. Spain is in a downward spin. With fewer taxes coming in there is less money to pay the bills. Tight bank credit has deepened the slump. Cuts are killing the economy, even more so than in the UK. Spain now has the highest rate of unemployment in the eurozone: 24.3 per cent. Among young people it is an unimaginable 51 per cent.  The OECD forecast the economy  will shrink 1.6 per cent more this year. Yet the conservative government in Spain, as in the UK, persists in the wishful thinking that cuts can bring the economy back to growth.

Instead the cost of borrowing is rising. On Friday investors demanded interest of 6.6 per cent to lend to the Spanish government. Italy, which is the world’s eighth biggest economy, was not far behind at 6 per cent. Both are dangerously approaching the 7 per cent threshold at which Greece, Ireland and Portugal had to seek European bail-outs.

What Spain should now be doing is focus less on austerity and more on cleaning up its banks. Spain’s poor public finances are a symptom not the cause of its economic woes. Private rather than government debt is its banks’ problem. What Spain wants is European cash injected direct into its banks from the European Stability Mechanism. Germany wants the money to go via the Spanish government so it assumes responsibility for the debt. But the Germans must know that, ultimately, if the euro is to work, there must be a centralised eurozone bank regulator. Fiscal union is the inexorable logic of a single currency. That is why Britain is better off outside it.

In the short term Spain is too big to fail and just about not too big to bail. The alternative – a chaotic series of exits from the euro with Greece followed by Spain and then Italy – would have consequences too unpredictable to countenance by anyone other than the maverick Silvio Berlusconi who last week called for Italy to quit unless the European Central Bank agreed to pump cash into the Italian economy and guarantee its government’s debts.

The danger is that none of this will happen through the negotiated decisions of politicians but through the hysteria of a market stampede. A run on the banks has, effectively, already begun in Spain and Greece where the country’s power regulator has called an emergency meeting next week to avert a collapse of electricity and gas supplies over unpaid bills. In two weeks Greece goes to the polls in what will virtually be a vote on whether or not to stay in the euro.  The outcome is too close to call. The danger is that the markets will make the decision before the voters can.

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