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Spain Holding Off Asking for Bailout, as European Leaders, Bondholders Ratchet Up Pressure

My hopes that the European Central Bank’s composition of a contingency plan in the event of high yields in places like Spain would be enough to keep those yields low doesn’t appear to be working out. The Spanish 2-year bonds have started to rise, from under 3% to around 3.5% in just a few days. The 10-year bond is holding under 6%. But that’s the highest they’ve been since ECB President Mario Draghi announced the bond-buying program. The subtle shifts upward ratchet up pressure on Spanish Prime Minister Mariano Rajoy to ask for a bailout with the European bailout fund. This would trigger the ECB bond-buying program they previously announced.

In addition, the Bank of Spain announced that bad loans in the banking system surged to 9.86% in July. The troubles of Spanish banks are even bigger than the price of sovereign debt; Spain just doesn’t have the money to cover more bank bailouts, and they would have to borrow more to handle it internally. This increased demand for borrowing would raise the price to unsustainable levels.

The Deputy Prime Minister suggested today that Spain could seek a bailout, but only if the conditions, i.e. fiscal demands imposed from outside the country, were favorable.

Spain will consider seeking a bailout if the conditions imposed are acceptable, Deputy Prime Minister Soraya Saenz de Santamaria said, the strongest signal from the government that it’s positioning to reach for the financial lifeline […]

“If we manage to bring those borrowing costs down to acceptable levels and that doesn’t imply an intolerable sacrifice for Spaniards, we will have to analyze it,” Saenz said today in an interview with Telecinco. “If we get our borrowing costs to fall, so we pay less, and if we manage to do that by doing reforms and without new sacrifices,” a rescue may be an option.

It would be political suicide for the Spanish government to have more austerity imposed on them, surely the conditions that would be demanded by the troika (the IMF, the ECB and the EU), at a time of nearly 25% unemployment. Rajoy has internal activist pressure, a separatist movement in Catalonia, and a series of promises made rejecting outside intervention in the country’s fiscal affairs.

These comments by Saenz really straddle the line. They would really only accept the bailout with no strings attached. But the entire point of the ECB’s program was to attach strings, and force the same wrong-headed austerity policies we’ve seen throughout Europe. There are also upcoming regional elections in Spain, and Rajoy would not want to announce a bailout before then.

Michael Burke is correct that Rajoy has the right position in resisting further austerity:

The ECB’s bond-buying also announced a red line it would not previously cross, widely but incorrectly called printing money. Crucially, this most dramatic policy change of all was made before Spain had submitted to the harsh treatment of a troika programme. In other cases the troika had maintained the fiction that the smaller countries of the EU could be left to collapse or even in the Greek case forced out of the euro area and the EU without any negative consequences for the core EU member states. But that assertion would have no credibility with regard to Spain.

The Spanish banking sector, like the banks throughout the entire EU, including Britain, is wholly dependent on support from the state, without which they would collapse. Letting Spain rot would exacerbate the run on Spanish banks. This would threaten not only the collapse of the state’s finances but take a large portion of the European banking system with it […]

The arguments between the Madrid government and the troika amount to who gets to decide the burdens to be imposed and which group of capitalists will be the main beneficiaries. Profits are already rising because of austerity, even in the midst of the slump. As a result, there are more than sufficient funds in Spain to cover the deficit and to finance recovery. There is no need for a bailout and the ECB has made it harder to force a bailout. It would be a national betrayal if the Rajoy government in Spain now asked for one.

Spain has leverage, should they choose to use it. They have the mechanism to force down bond yields in their back pocket and could always threaten to use it. Meanwhile, they know that they are essentially Too Big to Fail for the rest of Europe. It’s simply not credible for the ECB to threaten to withhold its bond-buying unless Spain knuckles under. The euro fell as the prospect of Spain not seeking a bailout in a timely manner rose. There’s a connection here that Europe would have to stomach. I don’t see it.

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David Dayen

David Dayen