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European Union agrees to bail out Spanish banks

Agreement won’t help Spain’s economic depression
By Masao Suzuki |
June 11, 2012
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San José, CA - On June 9, Spain and the European Union made an agreement to bail out Spain’s troubled banking sector. This agreement means Spain is the fourth country (along with Portugal, Ireland and Greece) in the eurozone to have to take a bailout.

The agreement will provide up to 100 billion euros ($125 billion) in loans to Spain’s bank bail-out fund, the FROB (Fund for Orderly Bank Restructuring). The agreement with the European Union was triggered by Spain’s third largest bank, Bankia SA, which needed a 19 billion Euro ($24 billion) bailout. But the FROB had only 9 billion euros, after three earlier rounds of bailouts of Spanish banks. The Spanish government, which would normally sell bonds to borrow money to bail out banks, was having a harder and harder time selling its own bonds.

Spain’s banks have billions of euros of bad real estate loans because of the boom and bust in the Spanish housing market. Spain’s housing boom was almost twice as large as the one in the United States, with construction spending accounting for about 10% of Spain’s Gross Domestic Product (GDP, the total spending on goods and service made in Spain), vs. 6% in the U.S.

Here in the U.S., big businesses have been able to bounce back from the financial crisis caused by the boom and bust in U.S. housing. This was aided by the U.S. central bank, the Federal Reserve, which printed some $2 trillion in money to buy financial assets, while the U.S. government spent another $800 billion on a bank bailout.

But Spain does not have the power to print money since it adopted the euro; rather this power lies with the European Central Bank or ECB. Spain’s government is also limited in its ability to borrow and spend money since its government bonds are not backed by the ECB.

As a result, while unemployment in the U.S. peaked at 10% and has since dropped to almost 8%, the unemployment rate in Spain has increased to almost 25% and is still rising. Over half the young people in Spain do not have jobs.

Spain actually had a small federal government budget surplus during its housing boom (with tax revenues greater than spending by 0.3% of GDP from 2000-2007). However the government budget deficit swelled to 12% of Spanish GDP in the aftermath of the 2008 financial crisis and deep recession in Europe that went hand-in-hand with Spain’s housing bust.

The Spanish government, first led by the social-democratic Spanish Socialist Workers Party (PSOE), and now by the conservative People’s Party, has instituted deep spending cuts and tax increases that have reduced the budget deficit from 12% to 9% of Spanish GDP. But this austerity has also led Spain into another deep recession, even before it had recovered from the 2008-2009 economic downturn.

These back-to-back recessions have dragged down the Spanish housing market, leading to even more losses at Spanish banks, which made a lot of loans during the boom times. Then in December of 2011, and again in February of this year, the European Central Bank made one trillion Euros (about $1.3 trillion) of long-term (three year) loans to Spanish and other European banks. But Spanish banks have already burned through almost all of this money in order to pay depositors withdrawing their money, and the rest, almost 40%, going to buy Spanish government bonds.

As the Spanish government had a harder time borrowing, the price of Spanish government bonds fell, causing even more losses among Spanish banks. Thus there is a need for another round of bank bailouts, to be paid for by the 100 billion euro E.U. loan.

While the bailout does put off an immediate Spanish banking crisis, it adds more European supervision to Spanish banks. This could worsen the Spanish depression if Spanish banks are forced to limit loans or even shut down to make the remaining banks more profitable. Spain’s unemployment rate is already close to 25%, the highest in the Euro-zone, and even higher than Greece’s unemployment rate. Industrial production (the goods produced by factories, mines, and refineries) in Spain has fallen 8.3% over the past year.

While the Spanish bailout does not have the severe austerity measures of tax increases and government spending cuts that have been imposed on the Greek, Irish and Portuguese people, it will make it harder for the Spanish government to borrow in the future. The EU bailout loan will be ‘senior’ to other Spanish government debts, meaning that the EU must be paid back before other owners of Spanish government bonds. This will make it harder for the Spanish government to sell bonds in the future.

On June 11, prices for Spanish bonds fell and their interest rate rose to more than 6.4% on a ten-year bond (in contrast, U.S. government ten-year bonds had an interest rate of only 1.6% on June 11). This increases the odds that the Spanish government itself may need a bailout or end up being forced out of the eurozone.

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