Spain spirals towards a saviour

Spain's banking system is in a perilous condition and could easily sink into a bond-fed death spiral. Consequently, the government's commitment to domestic solutions is looking similarly weak.

Spain’s borrowing costs climbed sharply overnight while Spanish bank shares were pummelled, as investors worried that the country will be forced to seek a bailout in order to cope with the festering problems in the country’s banking system.

Overnight, Spanish Prime Minister Mariano Rajoy emphatically denied suggestions that Spain would ask the European Union for funds to clean up its banks. But the country’s foreign minister, Jose Manuel Garcia-Margallo, had a different view.

According to a report in the Spanish centre-right newspaper El Mundo, Garcia-Margallo told journalists that the country was in the early stages of assessing the needs of its banks, and it was "not determined" whether the country would require help from the eurozone’s bailout fund.

"What is clear is that the government will guarantee the savings of the Spanish and the stability of banks so that they can lend to families, to businesses, so that they can begin to grow and create jobs,” he said.

In Brussels, there is little sympathy for Rajoy’s insistence that Spain will be able to cope with its banking woes without external assistance. Many see it as false bravado, which the Rajoy government is adopting because it had needlessly staked its reputation on avoiding a bailout.

The political confusion came as nervous investors dumped Spanish bank shares. Spain’s third largest bank, Bankia, saw its share price plunge 13 per cent, after the Spanish government announced a €19 billion ($US23.8 billion) bailout of the ailing bank. The move, which effectively nationalises the bank, has raised fears that the Spanish government will be forced to pump money into other banks that have suffered heavy losses following the collapse of Spain’s property bubble.

Some analysts estimate that Spain’s banks will need an extra €50 billion to €60 billion in fresh capital, which, investors fear, is much more than Madrid can realistically provide.

Banco Popular, which like Bankia has a heavy exposure to real estate developers, saw its share price slide by 7.5 per cent, while Banco Santander and BBVA, the country’s two largest banks, fell by 3.2 per cent and 3.4 per cent respectively.

The gloomy mood was exacerbated by a separate report in El Mundo which said that the Spanish government could be required to inject €30 billion of public money into three banking groups – CatalunyaCaixa, NovacaixaGalicia and Banco de Valencia – that have been put under state control because of the severity of their problems.

The newspaper quoted a Spanish government source as saying that if Spain’s borrowing costs remained elevated, Madrid could ask for help from the eurozone’s bailout fund in order to raise the €30 billion, in addition to the €19 billion required by Bankia.

"It’s a possibility, although at present all options are possible,” the source said. According to the newspaper, another option being considered by the Spanish government was to ask for IMF assistance.

At the same time, investors dumped Spanish bonds, pushing the yield on the 10-year bond to 6.5 per cent – perilously close to the 7 per cent level that triggered bailouts for Greece, Portugal and Ireland. Overnight, the spread between Spanish 10-year bonds and German bunds climbed to a record level of 511 basis points.

Investors are concerned that Spain is now trapped in a negative spiral. As bond yields rise, Spanish banks face even larger losses on their massive portfolios of Spanish bonds. Investors, worried that the Spanish government will be forced to pump in more funds to rescue the troubled banks, sell off bonds, pushing yields even higher and exacerbating the banks’ woes.

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